I think that if the stock market were entirely made up of domestic US investors who intuitively are familiar with the society here, the rational price would apply. But there are a lot of foreign investors who put money in for reasons other than rational analysis of market conditions.
True. But doesnt te surplus capital of foreign investors represent a valid force? Because they have capital and are seeking perceived value, they are willing to pay a higher valuation. Their valuation is a rational one, hence the price rises. Sad for a local investor if they feel they are 'priced out of stocks due to high PE ratio, but it is like Toronto RE. Dont buy the foreign goods if you dont want the profits coming back as investor capital.
That said, the genie is out if the bottle in terms of capital markets being global. Thats been a done deal since the 70s.
No, surplus capital of foreign investors is often seeking safe haven. Case in point is TenCent buying Tesla stock. The big story of the past five years is how capital is fleeing China for political reasons. While I'm sure TenCent might justify the purchase of Tesla stock as an astute investment, also a factor likely is getting money out of the Chinese market however possible.
Yes, Genie is out of the bottle. I remember when Dow Jones 1000 was a big deal. Still, it seems like money seeking safe haven in the United States has accelerated since the 2000's.
Maybe I dont understand your point.
The global economy creates wealth through economic activity.
The surplus capital (wealth above what is needed to reinvest in operations) seeks to be applied productively, so it acquires attractive assets, including stocks. This creates buyers in the market and if folks are willing to sell transactions occur.
How are wealthy Chinese any different from Jethro from The Beverly Hillbillies? Oil money from Arab Sheiks, banking money from London Financial Traders, South African Diamond money, Russian Maffia profits from software hackers, Natendos Pokemon Go windfall profits, The Gates Foundation seeking to invest its capital, etc. It all gets thrown into the mix.
Of course Chinese seek to diversify their wealth. They are now buying into the global economy, funded by their growth, and it is about time. Good for them. That was one if the goals of their reorganized economy: wealth creation, growing economic influence, etc. (i was there when the first western management consulting firm set up shop in Bejing...its been planned for decades). A good read is The Wealth of Nations by Adam Smith. Throw in Triad Power by one of my old bosses. These books are a bit dated, but the fundamentals remain the same. Capital is like water seeking its level. A force.
These booms, followed by distributions into equities are not anomolies, they are our global system (for good or ill). This is how the economy works.
Frankly, i would be worried is Chinese were not buying. By buying we cement together our mutual interests in a way that dramatically reduces the risk of global war, the one event that truely tends to tank economies and destroy assets.
Beautiful post. One counterpoint I'd like to add regarding "foreign safe harbor investments distorting market prices". IF people are saying that this investment is driving stock prices to be "overvalued" (whatever that means), an efficient market would mean that other rational investments would sell / short the stock in equal numbers, generating profits that would be invested elsewhere in undervalued assets. Hence the "leveling" effect of the market. Does this happen perfectly? No, but over time this lumpiness tends to correct itself.
While the definition of "corruption" is pliable, generally I do believe that there is simply so much foreign money coming into the United States that it kind of overwhelms any countervailing rational action.
In China, since Xi Jinping has taken office, there has been a humongous crackdown on "corruption" in China. Much of it is indeed embezzlement, much of it is less so, much is hazy. Nonetheless, China, and elsewhere, the inflows from the elite of those countries has a significant effect on the valuation in my opinion.
Which is fine. I'd argue it is in the national interest of the United States to have this huge stock market valuation where foreigners throw their capital. It is in the national interest for the United States to be a playground for the rich. But most students I talk to about the stock market simply don't see the rationality in valuations. Something else is going on here.
There are also other factors which I am omitting. Zero percent interest rates for the period after 2008 resulted in the money going to the stock market. Reinflating it was the strategy for recovery by the central bank. But all combined, and the traditional value investor who dutifully pores over number tables doesn't work now like it did in the past.