, the great Scottish comedian who recently retired from performing, had a joke about two men filming a lion for a wildlife documentary. The lion suddenly looks up. The men fear they have been spotted. One of them slowly removes his boots and puts on a pair of running shoes. “You will never outrun a lion in those,” says his colleague. “I don’t need to outrun the lion,” replies the first man as he slowly ties his shoelaces. “I just need to outrun you.
Share prices in America are at all-time highs. The cyclically adjusted price-earnings ratio, a measure of value popularised by Robert Shiller of Yale University, has only twice been higher than it is now—in the late 1920s and the early 2000s. Yet a recent study by Mr Shiller, Laurence Black and Farouk Jivraj suggests that today’s steep stock prices may still be warranted, because interest rates are so low.
All else being equal, you should be less keen to hold equities the lower the earnings yield is. But not everything else is equal. The price of assets should equal expected cashflows discounted over the life of the asset. The earnings yield gives you the “expected” part of this equation; real bond yields cover the “discounted” part. The gap between these two is a forward-looking measure of the equity risk premium, the excess return for holding shares.
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