Looking at absolute valuations is a problematic affair: the real interest rate has declined for 500 years (https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2020/eight-centuries-of-global-real-interest-rates-r-g-and-the-suprasecular-decline-1311-2018). When real yields decline stock valuations should go up. So looking at them vs gdp without adjust for interest rates does not work well.

Look at it this way: people have for hundreds of years accumulated financial wealth. This has particularly been the case since the 80s as the tax regime fundamentally changed in favor of companies and wealthy people. The wealthy don't hold much wealth in cash (say around 10% of their financial wealth) - they hold stocks and bonds instead.

As they accumulate more and more money due to income concentration they need to buy more assets. If the economy can't provide enough investment opportunity asset valuations will increase - which is another way of saying yields will decline.

You can look at relative valuations or at valuations relative to real interest rates. But spending too much time on absolute valuations just makes you miss out and generally feel miserable.

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Should stocks go up when real yields decline regardless of their valuation? Market caps to GDP are sky high but so are PE ratios. I have a problem with “real yields are low so stocks are the place to be.” Especially when interest rates are artificially low and printing money is causing inflation. The problem is that the store of value property of money has been destroyed.

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Essentially the more wealth people want to preserve for later consumption the lower the real interest rate will go and the higher the valuation of all assets will become. Ask yourself what is the alternative? Owning TIPS at -1% real yields? Owning cash at -6.2% real yield? The more money is being used as store of value the worse the returns become.

As example of how this works: say people want to hold 10% of their savings in cash and 90% in stocks. They can only exchange their cash with other investors who also want the same ratio in aggregate. What happens is the valuation of all stocks inflates through all this trading until all stocks can balance the cash investors have in their portfolios.

Ideally one would optimize the tax system to keep savings in line with the investment needs of the economy. Then yields would stay fairly constant (as new financial assets would get created representing the incremental investment in the economy) and the money supply wouldn't need to grow as fast, adding less debt to the system and keeping more purchasing power in the hands of consumers (which is ultimately good for asset holders as well).

Oh and one thing which took me a long time to figure out: it's not really that interest rates are artificially low. The fed basically just follows the market: when 2 year yields go up from the federal funds rate they raise interest rates. And when the 2 year touches the 10 year (i.e. the yield curve inverts) credit creation and economic growth stalls so the fed has to lower rates.

Keep an eye on the 10 year note. How far that moves up is the limit for how far the fed can go. And in my view that level just reflects the amount of savings chasing financial assets. Tax changes would be required to raise it - or Quantitative Tightening.

The fed is guilty of two sins through: the 2% inflation target which forces more debt on the economy than would otherwise be necessary. And traditional QE - which just exchanges assets for deposits in the financial accounts of the wealthy and thus increases the excess savings problem.

QE for consumers (helicopter money) as done during covid is a better solution since it directly stimulates consumption. But better yet would be a change in the tax system. At least in addition to helicopter money.

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Central banks (and governments) have made government bonds replace gold as the center piece of the monetary system. Now demand is so great for government bonds they have a negative (real) yield, and the market keeps buying stocks. We need an independent store of value.

Don't you think the market should have more options than stocks or bonds? (Of course they do but institutional money hasn't embraced any other yet.)

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"Now demand is so great for government bonds they have a negative (real) yield"

That's exactly it - the core issue is that demand for financial assets overall is excessive. And yeah gold, bitcoin, commodities, art etc all become more and more interesting as the traditional assets have become so expensive.

But why is demand so excessive? Because people have accumulated too much savings relative to the size of the economy and in particular the real investment needs of the economy.

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Rate are low...

1) because many financial institutions are required to buy government bonds: banks, pension funds, and insurance companies. See this professor explain https://www.youtube.com/watch?v=W6WNCr3hUvs

2) because of the printing press more and more debt is created and to keep this debt "sustainable" rates have to go lower and lower.

3) Additionally, in the current system, developing nations (Asia) "can" hoard foreign government bonds to hold down the local currency to export cheap stuff. More downward pressure on yields.

I don't see how this should justify sky high stock valuations. High debt means less consumption in the future.

In my view there is a lot to this that distorts the market in an unhealthy way.

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Just to be clear: I detest the current situation. I don't find it good or normal in any way. It's very unfair for the next generation to start saving in a world where no returns are available.

But be careful rg the cause effect relationships. Lets say for example that the fed had a 0% inflation target and that it would cleanly inject new central bank cash into consumer accounts to grow the money supply in line with gdp instead of banks creating deposits by granting loans. Given income inequality the wealthiest would still accumulate an ever larger proportion of savings and asset prices would inflate and rates go down if the tax system (and trade imbalance) stays the same. It wouldn't happen as quickly but end result would be the same.

"I don't see how this should justify sky high stock valuations. High debt means less consumption in the future."

Compared to cash or bonds stocks are not expensive now. You have some good points for why. But also consider: https://scholar.harvard.edu/files/straub/files/mss_richsavingglut.pdf

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