In the course of his discussion with Andrew Milligan,  Andrew Smithers, the author of a much discussed book, The Economics of the Stock Market, examined a variety of ways in which central bank, company and household decisions cumulatively influence developments in asset prices, frequently causing share prices to be over-valued. In particular he criticised many of the economic theories underpinning modern policy making. ‘By relying on these faulty models, monetary policy results in periodic financial crises’.

Andrew elaborated his thoughts on such issues as the different objectives and concerns of shareholders and business managers, so that business investment does not depend on the user cost of capital. Although low interest rates may give a short-term boost to share prices, the effect is temporary. Andrew explained in some detail his analysis of the q ratio, that is the ratio of share prices to the total  net worth of companies in a stock market, which like the cyclically adjusted PE ratio is mean reverting over time. In that regard, recent central bank QE policies and forthcoming QT policies have significant implications for the course of asset prices, over and above the effects of interest rate movements. Lastly, Andrew explained how financial history demonstrates that the three major classes of financial capital (i.e. cash, bonds and equity) are unrelated over most periods of time, as they are driven by different factors.

Andrew Smithers would be very happy to discuss any of these issues with SPE members. He can be contacted at: info@smithers.co.uk

He referred to several pieces of research in the course of his interview, including:

Interest Rates, Profits and Share Prices by James Mitchell (2009)
Appendix 3 Wall Street Revalued: Imperfect Markets and Inept Central Bankers by Andrew Smithers John Wiley & Sons Ltd.
Proof that Properly Anticipated Prices Fluctuate Randomly by Paul Samuelson (1965) Industrial Management Review.

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