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MikeFromNZ's avatar

I agree with @cchernoff, the thesis that the rise of passive management is somehow responsible for the increase in equity valuations is superficially appealing but sadly only half-baked.

Equity markets and other asset classes function as a kind of fourth dimensional wormhole, enabling today's savings to fund tomorrow's consumption. At a macro level, the key valuation driver is the cumulative stock of savings seeking to traverse this wormhole vs. the supply of assets available to transport this stock of savings into the future. At best, the behavior of intermediaries like active and passive managers might affect the valuation path, but they do not determine the destination. And in terms of path dependency, were active managers skillful in navigating this path due to their valuation-informed market timing expertise, assets would be flowing in the opposite direction, and we would all be worshiping Warren Buffet for his market timing skills.

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GoodHouse's avatar

Hey Mike great piece. This work that you’re doing is incredibly important. Keep it up!

While not denying any of the points you’re making, I wonder to what extent equities today “deserve” higher multiples than in the past thanks in part due to higher profitability for US corporations? Corporate margins are in double digit territory which is much higher than decades past. Hard to see them mean-reverting without significant policy shifts (particularly in areas such as antitrust).

Or perhaps do I have it backwards - are higher equity valuations creating conditions for higher corporate margins? (It would seem reasonable that higher valuations leads to more political power which leads to policies that further advance the agenda of corporations).

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