Wednesday, August 24, 2011

Ed Easterling on fair value

From Probable Outcomes:

“The concept of fair value relates to the appropriate value for the stock market given existing economic and market conditions. For example, when the inflation rate is in the mid-range, then bond yields should be in the mid-range to compensate for that level of inflation. Likewise, since stocks are financial assets, the stock market’s valuation level should reflect the conditions of inflation. As a result, fair value is a relative concept, not an absolute one. Valuation is relative to the inflation rate; it is not a level that is arbitrarily anchored to a long-term average.”

And a graph from Crestmont’s site showing the relationship: