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James Grant on Bubbles, Bargains

Forbes: Stocks. How much of that is a distortion? People would say some sectors are kind of dicey. But PEs overall, not too out of line.
Grant: Yes. There is such a thing in analysis called the dividend discount model. And it says that the value of an equity is the value of its projected cash flows discounted by a suitable rate of interest. And there’s more to it than that, of course.

But if the rate of interest one uses to discount cash flows is itself unsuitable or if it’s suppressed, that means the cash flows are exaggerated or inflated. And the price is higher than it would otherwise be. And I think that’s the risk in the stock market generally. I understand that many areas of the stock market are not certainly in the neighborhood of valuation where they were in 1999. But that doesn’t mean that things are fairly valued. And also I think more broadly, more fundamentally, we are all doing business in a kind of valuation hall of mirrors on account of the suppression of interest rates and the general body English that our federal masters are giving the stock market. They want it higher for the so-called wealth effect. Wealth effect, mind you.

Forbes: So putting aside all of the myths and the motions, the gold standard simply means you have a fixed value for money, which is supposed to measure value just as you have a foot for length or a scale for weight or a clock for time.

Grant: It is a weight or a measure. And that is all it is. For those of the viewers who did not see Steve and I debate, it seems like a long time ago. Anyways, we were in a debate. And we were up against a couple of paper money guys. And God, we were so eloquent. And the only extenuating circumstances of the debate was held in hostile territory, in the Upper West Side of Manhattan. And we got thunked.

Source Daily Reckoning

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