The Great Debate UK

from The Great Debate:

The equity illusion

John Kemp Great Debate-- John Kemp is a Reuters columnist. The views expressed are his own --

Even after its recent decline, the U.S. equity market does not look especially "cheap" or "undervalued" when viewed over time; the bear market has simply brought valuations back into line with long-term trends.

At a fundamental level, equity is a claim on a corporation's residual cash flow after wages, interest, taxes and other costs have been paid.

In aggregate, the total value of equity outstanding cannot grow faster than nominal GDP (which is simply the economy-wide sum of cash flows). Otherwise, corporations and their owners would need to capture an ever-increasing share of national income at the expense of everyone else.

For four decades between 1952 and 1992 this stable relationship between equity valuation and nominal GDP did indeed seem to hold in the United States.