This looks like a contradiction. But I’m not sure it is.
For one thing, high bond and equity prices are in part due to quantitative easing around the world: one purpose of this is precisely to raise asset prices and so boost capital spending by reducing companies' borrowing costs. There's no point saying that this means asset prices are "artificially" high; QE will continue in the euro area for at least another 18 months, and it won't be reversed in the UK or US any time soon.
There is, though, another reason why there’s no inconsistency between high bond and equity prices. Quite simply, shares aren’t overvalued.
The best evidence that they are is that the cyclically-adjusted price-earnings ratio on the S&P 500, at 27.8, is 66 per cent above its long-run average. But as I’ve said, this is not convincing. The post-1990 ratio has, on average, been quite high, at 25.3; it is high now, in part because earnings were unusually low in 2009; and the ratio doesn’t have great predictive power for returns anyway.
If you doubt this, just ask: where is the speculative froth we’d expect to see when shares are bubbly?
It's not in conventional valuation measures. The non-financial price-earnings ratio in the UK, at 16.5, is slightly below its post-1990 average and is only half what it was at its peak in early 2000. The FTSE 100 is at all-time high because profits are, not because valuations are high.
Nor is there evidence of froth in those segments of the market where we’d expect to see it. For example:
■ Growth stocks - as measured by the FTSE 350 low yield index - are lower relative to value stocks than they were in 2011. This is despite the fact that low bond yields should have raised their prices enormously; negative long-term interest rates should mean that future cashflows are more valuable than cashflows today which should mean that stocks offering future cash are enormously valuable. That growth stocks haven't benefited much from negative real rates is evidence that the markets' expectations for long-term growth are depressed. This is the exact opposite of what we saw in the 1999 bubble.
■ The Aim index is near an all-time low relative to the main market. This is evidence that sentiment is depressed.
■ High beta stocks (as measured by our no-thought portfolio of the 20 highest beta shares) have under-performed the market in the past 18 months.
Less quantitatively, but also important, is the absence of bullish stories. Of course, plenty of people expect economic growth to pick up this year. But very few are telling optimistic stories about long-run growth of the sort that we heard during the tech bubble.
I'll concede that there might be one sign of froth. Equity issues have picked up; there were £22.6bn of them last year. But even this is much less than we saw in 1999-00. And it is only 1.1 per cent of the market's capitalisation. This isn’t much, considering that the purpose of the stock market is to allow companies to raise cash.
Perhaps, then, there is no paradox at all. Shares are not expensive, at least not on the basis of existing information. Indeed, given that QE and low long-term yields should be inflating their prices, what's notable is their lack of expensiveness. This does not mean you should rush out to buy. It might instead mean that shares actually agree with bonds - that there is indeed a big risk of low long-term growth.
