Consumer prices are up 20% since the end of 2019. Interest rates have gone from 0% to 5% over the same time. Financial conditions have tightened, and yet the stock market hasn’t broken. If you had known the future paths of the two most important macro variables, inflation and interest rates, you would have thought the stock market would be significantly worse off than it is today.
Aswath Damodaran explained why stocks aren’t down more on Invest Like the Best with Patrick O’Shaughnessy
If you think about having a low cost of capital, it should push our value, but here is the counter. Those low interest rates also told me that there was going to be low inflation and low real growth in the future, so, and I projected that growth for these companies for the long term. I also pushed the growth rate down to reflect those same views.
So the same low inflation that pushed interest rates, and also when my growth rates were low, my pricing power was lower, the effects in a sense offset. That’s why my valuations don’t change dramatically. And that’s why I’m not surprised the market hasn’t imploded because if you left everything as is and kept the same cash flows you had two years ago, and you raised the discount rate by 2% or 3% or 4%, which is what we have, stocks should be down 40% or 50%, they’re not.
And the reason for that is companies are flexible. They’re adaptable as inflation comes through, guess what they do, they pass that inflation on to U.S. customers. And the companies that are better suited to doing that are more protected against inflation.
The whole conversation is worth listening to. Damodaran riffs on smart money, the future of active management, and so much more. Cannot recommend it highly enough.