Sunday, October 29, 2017
Stock valuation: portfolio theory versus discounted PV
Apropos of nothing,
1. Stock (or bond, or land, or anything) market prices don't depend on their discounted net present value of future flows.
Yes, the underlying value of an investment is its discounted NPV of future flows, but "underlying value" doesn't mean much.
Investment prices depend on how much money chases how much paper. That's all.
2. The population is heterogeneous in consumption and saving; the marginal propensity to consume is real. In fact, any "economist" who doesn't admit this is a fraud.
3. The population at the low end of the pay scale (where all money is going into consumption) contribute directly to a business' NPV of future flows.
Thus, when low-pay people are seeing big raises, the underlying value of investments will tend to go up.
4. The population at the high end of the pay scale invests more than it consumes. Thus, when the high-paid population are seeing big raises, they contribute to inflation of investment prices.
5. Thus, any long-trend divergence between underlying investment values and market prices is indicative of more money going to the rich.
6. Equities and bonds are not capital; capital investment is productive investment, while equity and bond investment is just the purchase of money flows.
Yes, when investment in productive capital provides a higher return than investment in (say) zero-real-yield-or-worse bonds, then money should flow into investment in productive capital. Productive capacity will increase, and thus the economy grows in size.
But, money will not flow into generating new productive capital when there's no expectation of consumption growth. (Capital investment behaves according to a risk-averse utility function.) It also won't flow into generating new productive capital when monopolistic/oligopolistic power contributes to a new firm entry cost that's higher than the paltry expected returns in a no-consumption-growth market.
Thus, the only place for money to go is bonds and stocks.
Plutocracy results in a stagnant economy and grossly inflated asset prices.
Inclusive economic equality will result in deflated asset prices and high economic growth.
You can give me my Nobel Prize any time.