My problem with this argument is good old Benjamin Graham. I guess u have read the intelligent investor, original 1949 edition? remeber those wild passages about what is a good yield on a decent corporate bond and an appropriate multiples and dividend yields for comon stocks? I read this book like in 2005 and a was thinking to myself – gee, the investment community was kind of nut at that time! Then i started reserching the Fed model and similar valuation metrics, while doing my CFA charter and stumbled upon this paper, which was linking multiples and prior realized volatilities, it was back tested on 150+ years of DOW and SPX data(lost the link and can not find it with quick search on the web).

The basic result was quite obviuous in hindsight. The equity valuations for an average guy is really not only a function of interest rates but also of past realized volatility. The bumpier the ride before, the riskier the the asset is considered to be. It’s perfectly in line with the anchoring and other investor’s cognitive biases.

This effect should be fading by now since we have a lot of pros managing other people’s money but, for the average mom and pop investor i think this should be true still.

Given all that, in my view, there is a very good cahnce that this bonds over stocks mentality is not a bubble, but rather a secular shift. I am not willing to bet the farm on that, but for what it’s worth…

Sorry for a terrible english, i am a russian native and moscow resident.

I don’t just mean the bond funds that held Fannie/Freddie debt. (In 2008, I found no UST bond funds that didn’t also hold at least 7% of their portfolio in F/F.) Consider that government bailouts prevented many companies from bankruptcy, where your bonds would’ve taken a haircut. Government also explicitly guaranteed money markets.

Take away government supports? “Stable value” funds would’ve been anything but.

Will they do it again next time, when the debt-to-GDP is even higher? Possibly.
If they do, will you be able to buy much with your currency? Possibly.

That might be the smart move next time, too. But, only if it’s favored again by government intervention.

That said, I think you are confused by this debt fallacy. Debt has not risen in any way materially differently 60s, 70s, 80s, 90s. Debt is a natural consequence of “wealth” as saving and debt balance. Sure this looks exponential… so does our GDP and our total net worth. Debt is just recycled savings. There is also a move away from cash and toward credit/rate based money supply. This is the natural consequence of modern technology and good monetary policy. Neither is to be feared. The economy will grow 3% real, and hopefully +2-3% inflation. I think our main problem is a deflation problem.

I wasn’t the one who countered your statement with “house prices will not go down”. You confuse me with someone else.

As for your assertion, that a P/E ratio of 7-10 relates to an interest environment of about 15%. Again, you make the mistake to deduce an alleged relationship from only one case. That P/E ratios of 7-10 were being observed when interest rates were very high was true for the early 80s. Isn’t this alleged inverse relationship between stock prices and interest rates (10 year treasuries) the so-called Fed-model, or do I confuse this? However, for the other instances when the P/E ratio hit 7-10 at the end of bear markets, the interest rates were much lower, partly even lower than today.[1] So I don’t see in the data what you claim.

As for the business cycle. Do you believe we are just in a cyclical trough in the business cycle, and after we will have got out of it things will go back to business-as-usual as it was in the previous expansion phase with respect to economic growth, profit expansion of companies, and stock market prices? I ask because I don’t see where this economic expansion is going to come from this time, after growth in the expansion phases of the business cycle has been essentially fueled by a doubling of private credit per 10 years over the last three decades, and I don’t really see that households and private businesses (w/o financial institutions) will increase their debt load by another 25 trillion US-dollars over the next 10 years.

[1] http://www.multpl.com/interest-rate/

rc

The problems with your market analysis is that PEs, Earnings Yield, and Div Yield all need to be seen in relationship to the RFR and yield curve.

Therefore PEs of 7 or 10x in the early 80s corresponded with interest rates of 10-20%. The low print on PE actually was in a ~15% interest rate environment.

The economically connects through companies ability to equity or debt finance and similarly through M&A of levered buyout. Notice the big uptick in M&A over late 2009? This is because large conglomerate companies can finance at 2-3-4% pre-tax and are quite willing to buy growing EPS streams at 20-25x PE or 4-5% post-tax. Especially when they see this as a trough in the business cycle.

We do believe in the “business cycle”, dont we?

I said there was no sense in the argument… “anything that can happen… eventually will happen.”
I made a number of specific (farsical) counterpoints.

You countered with – “house prices will not go down”.

This do not fit the pattern at all. First, saying very basic things “cannot” happen is quite agreed to be a mistake. I agree. Markets go up and down. Fade the last 5-10yr bubble (like housing). But this is much different then saying… “the end is nigh”. People have been saying that for millennium. They have yet to be right.

I’m not arguing that taxes are the dominant factor. But one to consider.

On an after-tax basis, there are various benefits to capital gains, rather than dividends. One is that if you wait long enough, a tax-cutting president will come along. (Even Clinton lowered some taxes). Another is that capital gains on one investment can be offset with capital losses on another. Another benefit, for long-term holders of assets, is that in transferring assets to heirs, there is a “stepped up basis cost”. The same principle applies in the case of charitable donations.

I don’t think that one can readily prove that higher dividend taxes result in lower dividend payouts on the SP500. But neither can one prove, based on the historical evidence, that it is not a factor.

Bonds might not be in a bubble, but they are definitely going to get slaughtered.