{"text":[[{"start":4.95,"text":"“If something cannot go on forever, it will stop.” So said Herb Stein, former chair of the US Council of Economic Advisers, back in 1986, about American debt."}],[{"start":16.4,"text":"Investors might note Stein’s adage again, this time around asset valuations. For a peculiar — and possibly unsustainable — paradox currently haunts markets. No, this is not (just) the hitherto muted reaction of oil prices to the Iran war; nor the eye-popping scale of looming initial public offerings from SpaceX and Anthropic."}],[{"start":34.3,"text":"The real conundrum is bond and equity yields. For decades, business school students have been taught that equity yields are supposed to be higher than those for bonds, to compensate investors for risks with corporate earnings and market cycles. "}],[{"start":48.699999999999996,"text":"As Smith Affiliated, a New York investment adviser, notes in its latest investor letter, between 1990 and 2026 the US equity yield was indeed 2.3 percentage points above the yield for 10-year government bonds on average. (Smith arrived at this number by dividing S&P 500 corporate earnings by market price, which is arguably the simplest current measure.) "}],[{"start":72.44999999999999,"text":"But “today, that relationship looks very different”, Smith says: the S&P 500 earnings yield was around 3.6 per cent in early June, around 0.85 percentage points below the 10-year Treasury yield. Financial logic has been turned upside down."}],[{"start":89.44999999999999,"text":"Other analysts calculate this equity yield differently. JPMorgan, for instance, uses a complex Dividend Discount Model that projects future (not current) earnings and discounted cash flows."}],[{"start":101.19999999999999,"text":"But the message is similar: between 1996 and this year, JPMorgan’s equity premium has mostly hovered around 5 per cent. Since bond yields started sliding down three decades ago, towards zero, this created a large positive equity/bond gap. "}],[{"start":117.74999999999999,"text":"Now, however, 10-year yields top 4.5 per cent, so the gap shrunk in JPMorgan’s models — meaning that “equities look rather expensive . . . on an outright basis relative to the norms of the past 30 years”, according to the bank. And “equities currently look even more expensive relative to bonds”."}],[{"start":138,"text":"This is odd. After all, when market interest rates surge — as they have this year — this usually hurts corporate earnings, and makes it more attractive for investors to buy bonds. Yet the S&P 500 has (mostly) shrugged that off. "}],[{"start":153.85,"text":"Why? One possible explanation is that bonds are mispriced, either because inflation is about to plunge, or governments are about to slash their debt and/or a recession looms. However US inflation has just hit 4.2 per cent, first-quarter growth was 2 per cent and the US deficit was a record $1.2tn for the first eight months of this fiscal year, while Treasury projects a $2tn deficit this year. "}],[{"start":180.95,"text":"So a second possibility is that it is actually equities which are mispriced. This seems more likely. After all, the recent wild tech rally — and exuberance around artificial intelligence — accounts for much of the surge in equity indices even though tangible profits from AI have hitherto been slim. "}],[{"start":200.6,"text":"Worse, there could be investor indigestion soon with all the looming IPOs, given that we also seem to be embarking on a new investment cycle, and the Treasury needs to sell $10tn of bonds in the next year. As Smith says, we face “the return of competition for capital”. This is very different from the last decade of excess liquidity, which bolstered equity prices."}],[{"start":222.79999999999998,"text":"Yet if you think equities are mispriced you need to contend with two other points: corporate earnings are still strong, even outside tech; and most techies (and investors, it seems) are convinced future tech profits will soar. "}],[{"start":235.54999999999998,"text":"Thus the chatter at a Founders Forum meeting in the UK this week was about a future AI-triggered profit, productivity and growth miracle, which could reduce inflation. To the tech world, then, it is bonds — not stocks — that look mispriced. Scott Bessent, US Treasury secretary, appears to agree."}],[{"start":254.54999999999998,"text":"If this turns out to be correct, we can all celebrate. But I remain wary, and fear that there is a third explanation for this conundrum: investors are so dazed and confused that valuation models are breaking down. "}],[{"start":267.75,"text":"After all, most corporate and financial professionals grew up in a world where neoliberal economics, globalisation and Pax Americana were their definition of “normality”. It is thus tough to parse our new era of geoeconomics, the real-economy impacts of AI, or the future of the oil price and the dollar with Donald Trump in the White House. Uncertainty abounds. "}],[{"start":288.1,"text":"So will this market paradox last? Probably — for a while at least. After all, Stein made his quip four long decades ago, but debt has continued to expand. And in the equity world, the dotcom bubble lasted longer than anyone expected (producing low equity yields too). "}],[{"start":304.75,"text":"But, if nothing else, investors should pay attention to this conundrum, and then ask themselves what they trust: a promise from the US government to get debt and inflation under control? Or a pledge from techies to deliver wild future growth? Or neither? The answer matters deeply, particularly if capital scarcity does return."}],[{"start":331.65,"text":""}]],"url":"https://audio.ftcn.net.cn/album/a_1781317282_3540.mp3"}