In the current environment, it is difficult to assess fair value for financial assets, due to several extraordinary factors. The macro environment is unsettled and the risk of a severe financial shock due to a disorderly eurozone breakup is quite real, as discussed below. Massive government intervention in bond markets has distorted yields. Despite losing AAA status, U.S. bonds still remain the world’s benchmark for bonds and for the assessment of earnings yield on stocks. Normalization of bond yields keep getting delayed due to the slow process of private sector deleveraging, the weak economies of rich countries and the constant threat of debt deflation. The Fed’s most recent position is that exceptionally low yields will remain in place through 2014. The durability of corporate earnings is also questionable, as U.S. profit margins are at an extreme level and could soon begin to decelerate (Chart 1).
Equity Valuation and the Euro Crisis
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