The stock market indices are above their pre financial crisis highs. One interpretation of this is that the financial crisis was just that: a crisis of the financial sector that left the rest of the economy largely untouched. Another interpretation is that we are simply looking at the results of way too much cheap money provided by the Fed. The latter is supported by a chart that I saw yesterday for the first time which shows the Dow divided by the price of gold. That chart is essentially flat since the crisis. In other words the stock market has not risen at all when denominated in gold.

Does that comparison even make any sense? It does if you believe that the price of gold is essentially an indicator of there being too much cheap money. If you think the price of gold is driven entirely by a (potentially irrational) fear of future inflation you can pick another comparison that has a similar effect: interest rates. I haven’t tried to do this but I am pretty sure that if you normalize the stock market for interest rates you will get a similar picture to gold.

With the risk free rate being near zero, future cash flows count for a lot more than with higher interest rates. So when you look at stock prices through from a DCF perspective you would expect them to go up a lot as interest rates go close to zero, especially for companies that are deemed to be low risk. Apple just borrowed $17 billion at rates as low as 0.45% for 3 years. Even if you add quite a bit of risk for equity you are still likely to come up with historically low discount rates.

There is one other factor that has been driving the market though in addition to cheap money and that is cheap labor. I have written about the changes in employment extensively before but the flip side of that has been higher corporate profits. Apple of course is one of the firms that had record profits and it is borrowing now only to avoid paying taxes. In combination the changes in the labor market and the cheap money are the key contributors to the immense inequality we are facing.

Bottomline then is that the market is high. But it is high on cheap money and cheap labor. Neither of which is ultimately sustainable (although both are likely to go on for quite some time).