Sky-high equity valuations here to stay?

• Have we witnessed the formation of a US equity bubble on the verge of bursting? Or can current valuations be justified by a shift in macro fundamentals?
• We model an S&P 500 fair value range and attribute medium-term price changes to their fundamental drivers. We find that the nine-year bull run can be largely explained by rising dividends and falling real yields. Elevated valuations are consistent with compressed discount rates and, without a significant repricing of real yields, they could be here to stay.

International borrowing and the US dollar

• Some market participants are worried about the ever rising market value of US borrowing vis-à-vis the rest of the world – as measured by the Net International Investment Position
• Currency depreciation can function as an effective method of adjustment following an increase in external borrowing
• However, there are reasons to be cautious about this line of thinking, especially with respect to the US dollar. These include asset valuation effects, and the role of the US as a global facilitator of excess saving.

Asian “Currency Manipulation” : Mainly a US Concern ?

• The US has had a long standing concern about what it perceives to be excessive “currency manipulation” on the part of some countries, especially in Asia. This concern is primarily driven by the large and persistent US current account deficit, which will necessitate significant relative currency adjustments for it to at least begin to unwind.

• A problem with this view emanating from US officialdom is that the pass-through effects between currency movements and domestic inflation in the US has been shown to be weak, thus making the process of adjustment more drawn out at best, and ineffective at worst.