The Role Of Negative Real Bond Yields In New Record Highs In Stock Prices

It sure seems like somebody sent Paul Krugman a link to my post the other day about Why, despite the worst economy since the Great Depression, the stock market has made a new all-time high. Because he wrote a series of tweets that look like a direct reply.

So here is my response.

To recapitulate, on Monday I suggested that the answer to the conundrum primarily consisted of 3 reasons: 

1. Background longer term fundamental factors [particularly all-time low interest rates] for the economy are very positive.

2. All other industrialized countries beside the US have controlled the pandemic [so global companies’ earnings will reflect that].

3. Market gains are completely bifurcated, and are essentially limited to the 6 biggest players [FAANG+Microsoft] in the global economy and in home delivery [so companies whose footprint is either digital or based on home deliveries especially benefit].

As an aside, although I specifically declaimed that my explanation had no “actionable information” for stock investors, Seeking Alpha picked it up anyway, and so far it has about 70 comments there. But back to the main point.

On Wednesday, Paul Krugman weighed in with a series of tweets:

To rephrase his tweets in terms of my thesis:

1. Yes, but short term profits over the next year of so shouldn’t matter [because Paul Krugman is a macroeconomist who can’t help but think in terms of rationally discounted value out to an ad infinitum future]

2. Zzzzzz. 

3. Yes, and beyond that, FAANG+Microsoft are able to charge monopoly rents for the foreseeable future.

4. BUT, since government bonds yield less than the foreseeable inflation rate, bidding up profitable companies is a rational investment decision. And further, “anyone talking about stocks without mentioning bond yields is missing a large part of what’s going on.”

Herewith, my response.

Corporate profits are a long leading indicator for the economy; stocks a shorter leading indicator. Unsurprisingly, over the long term corporate profits lead stock prices, not visa versa. Here’s a graph of that going back to 1987:

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