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Macro Mechanics

The Equity Bubble?

Macro Mechanics

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Prometheus Research
Aug 14, 2024
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In this note, we share our thoughts on the macro mechanics at play in the context of the current economic cycle. If well received, we will continue to share these Macro Mechanics.

The economy remains in expansion, but there has been some moderation in the labor force. However, equity markets remain extremely elevated in price and valuation. This begs the question: Can equity markets continue this historic rally?

Let's begin with the basics. The return on stock is equal to the return on cash, the dividend yield, and the price appreciation of the equity in excess of cash. Prices can be appreciated because the expectations of earnings rise or investors simply allocate more risk to equities.

What’s important to recognize is that all of the drivers of equity return in excess of cash, are all a function of pro-cyclical forces in the economy. That is, when the economy is expanding, and earnings are good - dividends, buybacks, earnings expectations, and risk allocation can rise at the same time.

Therefore, the set of questions you’re trying to answer when you allocate to equities are as follows:

  • Is the economy in a good position?

  • Are earnings expectations reasonably consistent with the economy or are they cheap/expensive?

  • Are investors over/under/fairly exposed to equity markets for the given fundamentals?

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