Monday, February 04, 2008

Fed Policy Makes U.S. Stock Markets Overvalued

Bloomberg news reports that the U.S. stock market have actually performed better than most other stock markets during the recent stock market decline. This may appear puzzling and strange considering the fact that the reason for the sell-off is the U.S. recession, and despite globalization, U.S. companies are still more likely to suffer from it than other stock markets.

The explanation for this lies in the fact that while the Fed has cut interest rates dramatically, other central banks have only cut them slightly (as in the cases of Bank of Canada and Bank of England), kept them on hold (as in the case of the ECB and the Bank of Japan) or even raised them (as in the case of the Swiss National Bank or the Swedish Riksbank). This have also caused market interest rates to fall sharply in the U.S. (particularly for shorter maturities) while they have remained relatively unchanged elsewhere. This in turn means that in the U.S. the alternative of bonds appear far less attractive than in the past, while such a shift haven't happened elsewhere. And because of that, equity valuations have risen sharply in the U.S. compared to other countries. Or in other words, not only do U.S. bonds appear far less attractive than elsewhere, but U.S. stocks also appear less attractive than stocks in other countries. One can discuss to what extent this reflects absolute overvaluation of U.S. stocks or absolute undervaluation of non-American stocks, but in any case, U.S. stocks are certainly overvalued in relative terms.


Anonymous Johan said...

I suspect it is also only true in the very short term, looking at the various indexes relative to gold or oil?
Sure, as Marc Faber recently said, the Dow could even end 2008 up in nominal terms, but that doesn't mean it's up in real terms.

9:10 AM  

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