When Markets Drive the Economy, Cash Flow is King
by David Rosenberg, Gluskin Sheff, via FT.com Contribution
October 29, 2012 - FT.com - There was a time, not that long ago, when it was the economy that drove asset prices such as equity and real estate valuations. Today, the causation is viewed, even in policy circles, as running in the opposite direction. It is asset prices that now drive the economy.
There was a time, again not that long ago, when the Federal Reserve cut the overnight rate when it wanted to stimulate the economy and stir investor animal spirits. But policy rates have been zero for nearly four years. The Fed has resorted to unconventional measures for more than three years and the latest move towards open-ended quantitative easing is the boldest step yet.
The Fed has completely altered the relationship between stocks and bonds by nurturing an environment of ever deeper negative real interest rates. Therein lies the rub. The economy and earnings are weak, and getting weaker, but the interest rate used to discount the future profits stream keeps getting more and more negative and that, in turn, raises earning expectations. The fact that the S&P dividend yield is triple the yield in the belly of the Treasury curve has also added to the allure of equities, or at least those that have compelling dividend yield, growth and coverage characteristics.
Until 2009, there was absolutely no correlation ...
