An economist’s warning for stock market investors | Kitco News

In his latest book, “The Economics of the Stock Market”, veteran economist Andrew Smithers lifts the corporate veil to reveal a world in which the managers of public companies put their own interests first and seek to maximise current share prices rather fundamental values.

David Ricardo started his career as a stockbroker, while John Maynard Keynes was the bursar of his Cambridge college and chairman of a life insurance company.

If managements aimed to maximise the net worth of their businesses, they would issue shares when the cost of equity is low and use the capital for investment.

Finance theory suggests that a company’s valuation should not change whether it is financed with equity or debt.

Finance theory denies that we can identify a stock market bubble in real time: future share price movements are unpredictable.

Smithers suggests the best way to value equities is to compare their market price to the cost of replacing underlying corporate assets.

Because Tobin’s Q is not a practical valuation tool, most investors prefer to compare earnings yields – a company’s earnings per share divided by its share price – with bond yields.

After the October 1929 crash it took around a quarter of a century for the market to regain its previous peak.

A prolonged period of underinvestment has put American public companies at a competitive disadvantage to foreign-owned firms. The corporate sector has also taken on near-record amounts of leverage.

Besides, just because the return from stocks has been stable in the past doesn’t mean that equities must deliver the same return in future.

stocks has remained elevated for so long is because the Federal Reserve has supported Wall Street with ever-lower interest rates and successive bouts of quantitative easing.

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