TheChek News Flow

FT : Biden Administration Presses Allies Not to Confront Iran on Nuclear Program

Biden Administration Presses Allies Not to Confront Iran on Nuclear Program

U.S. is arguing against an effort by Britain and France to censure Iran at the IAEA’s member-state board

BERLIN—The Biden administration is pressing European allies to back off plans to rebuke Iran for advances in its nuclear program, even as it expands its stockpile of near-weapons-grade fissile material to a record level, according to diplomats involved in discussions.

The U.S. is arguing against an effort by Britain and France to censure Iran at the International Atomic Energy Agency’s member-state board in early June, the diplomats said. The U.S. has pressed a number of other countries to abstain in a censure vote, saying that is what Washington will do, they said.

U.S. officials deny lobbying against a resolution.

The differences are emerging as Western officials’ concerns have deepened about Iran’s nuclear activities.

On Monday, the U.N. atomic-energy agency reported that Iran’s stockpile of 60% highly enriched uranium rose 20.6 kilograms to 142.1 kg as of May 11 from three months earlier, its highest level to date.

U.S. officials say that material could be converted into weapons-grade enriched uranium in a matter of days. It would then be enough to fuel three nuclear weapons.

Some U.S. officials say they fear Iran could be more volatile as the country moves toward elections for a new leader after the death of President Ebrahim Raisi in a helicopter crash earlier this month. The Biden administration has long said it is seeking a diplomatic solution on Iran’s nuclear program.

European diplomats have warned that failure to take action would undermine the authority of the IAEA, which polices nonproliferation of nuclear weapons. They say it also weakens the credibility of Western pressure on Iran. And they are frustrated over what they see as U.S. efforts to undermine their approach.

A U.S. official said Washington is “tightly coordinated” with its European partners ahead of the IAEA board meeting next month: “Any speculation about decisions is premature.”

“We are increasing pressure on Iran through sanctions and international isolation,” the official added, citing measures taken by the Group of Seven advanced democracies after an Iranian missile and drone attack on Israel last month.

A second U.S. official said it was “totally false” that Washington is aiming to avoid disruption with Iran before the U.S. elections.

The IAEA board last passed a resolution rebuking Iran in November 2022. U.S. and European officials in Vienna have repeatedly warned since then that they would take action if Tehran didn’t rein in its nuclear advances and step up cooperation with the agency.

At the heart of the dispute are concerns in some European countries, particularly France and Britain, that Washington lacks a strategy for dealing with Iran’s nuclear advances. European diplomats have said that the Biden administration appears unwilling to either pursue a serious diplomatic effort with Iran or take punitive actions against Tehran’s nuclear transgressions.

The Europeans were strong supporters of the 2015 nuclear deal, which lifted most international sanctions on Iran in exchange for tight but temporary restrictions on Iran’s nuclear work. Europe sought to preserve the accord after the Trump administration exited it in 2018.

The Biden administration set revival of the nuclear agreement as a top foreign-policy goal when it took office. But talks collapsed in August 2022 when Iran hardened its demands. Since then, U.S. officials have sought to contain tensions with Iran.

U.S. officials argue that Europe could do more to increase pressure on Iran, including cutting off Iranian banks that work on the continent and listing Iran’s elite Islamic Revolutionary Guard Corps as a terror group. They note they have coordinated sanctions efforts with Europe against Iran over its missile and drone transfers.

Washington has its own strategy for raising pressure on Iran over its nuclear activities, which includes asking the IAEA to prepare a comprehensive report setting out everything it knows about Iran’s failure to cooperate.

While a report would have no automatic consequences, a similar effort in 2011 focused international attention on Tehran’s nuclear buildup, generating momentum for international sanctions on Iran.

U.S. officials say if Iran doesn’t change direction, such a report could build the case for a snapback of international sanctions lifted under the nuclear deal, which is an option that expires in October 2025. European officials say they have been told Washington is considering asking the agency to present such a report after U.S. elections in November but has no immediate plans to request it.

Iran is already effectively a threshold nuclear state, and there are growing Western worries it could seek to become a nuclear-weapon state.

In addition to accumulating highly enriched uranium, Iranian officials have suggested Tehran has mastered the process of building a nuclear weapon. Others have suggested that Tehran could reverse Supreme Leader Ayatollah Ali Khamenei’s ban on weapons of mass destruction.

Iran insists its nuclear program is for civilian purposes. The U.S. intelligence community and the IAEA say they have no evidence that Tehran is building a nuclear weapon. Tehran started expanding its nuclear program after the U.S. pulled out of the nuclear deal.

Iran has reduced the IAEA’s oversight of its nuclear program and for years stonewalled an agency probe into undeclared nuclear material found in recent years in Iran.

A censure resolution at the IAEA Board can open the way to pushing Iran’s alleged noncompliance on nuclear issues to the U.N. Security Council for an international response.

Tehran has repeatedly escalated its nuclear program or taken fresh action to limit inspectors’ access in recent years when it has come under Western pressure over its nuclear program at the IAEA meetings. Last year, after facing verbal criticism at the board, it banned a number of experienced European inspectors from the country.

The U.S. fears a repeat of those kinds of steps if a censure motion goes through.

The administration is also skeptical that a formal rebuke will achieve anything. Even if Iran’s nuclear work is eventually pushed up to the U.N. Security Council, it would likely be doomed there. Russia and China, who hold veto power at the U.N., would almost certainly veto any attempt to sanction Tehran for its activities.

This time, British and French officials have told Washington they want to press ahead with a censure resolution, saying it was time to draw a line, according to people involved in discussions.

Whether the Europeans actually would do that is unclear. If they proposed a censure motion that failed, it would be a major diplomatic coup for Tehran, suggesting Western pressure on Iran was crumbling.

The U.S. has pushed against a censure resolution at the IAEA ahead of other recent board meetings, but past disagreements over how to handle Iran’s nuclear work have largely stayed between Washington and the Europeans.

However, at the most recent board meeting in March, Washington’s ambassador to the IAEA, Laura Holgate, warned that Iranian noncooperation with the agency couldn’t be allowed to continue.

“Iran’s level of cooperation with the agency remains unacceptable,” she said at the meeting. “The board must be prepared to take further action should Iran’s cooperation not improve dramatically.”

Earlier this month, IAEA Director General Rafael Grossi traveled to Iran to try to improve cooperation, calling for Tehran to take concrete deliverable steps before the June board meeting to show its good intention. No such steps have been taken, and diplomats in Vienna say they don’t immediately expect any.

In a bid to contain flashpoints, U.S. officials this month held their first discussions since January with Iranian officials in Oman. The indirect talks, which involved Omani officials going back and forth between the sides, touched on regional and nuclear issues, according to people briefed on discussions.

Mark Dubowitz, chief executive of the Foundation for Defense of Democracies, said a censure resolution would help set out a record of Iranian noncompliance that could ultimately lead to a snapback of international sanctions.

Kelsey Davenport, director for nonproliferation policy at the Arms Control Association, said a censure was overdue but that it should be tied with a diplomatic effort to rein in Iran’s nuclear program for sanctions relief.

“The board needs to send a message to Iran that there are consequences for stonewalling,” she said. “But it needs to be part of a broader strategy. The goal should be pressuring and incentivizing Iran to cooperate with the IAEA and expand their access.”

FT : Six years of UK rail reform has ‘achieved very little’, say MPs

Six years of UK rail reform has ‘achieved very little’, say MPs

Promises of overhaul hampered by legislative delays and interdepartmental rows, finds public accounts committee

The UK government has “achieved very little” during six years of attempted railway reform, MPs have said, concluding that “no one is putting the needs of passengers and taxpayers first”.

The House of Commons cross-party public accounts committee found that repeated promises of a “root and branch” overhaul of the rail system have been stymied by legislative delays and disagreements between government departments.

MPs also said they had yet to see any evidence that plans for Great British Railways, a new public body intended to oversee services and infrastructure, would actually be any different to previous promises of reform over the past 20 years.

“Meanwhile, no one is putting the needs of passengers and taxpayers first,” said the committee’s report on the ruling Conservative government’s rail programme, released on Monday.

“Although the department [for transport] claims that improving passenger experiences is at the heart of its reform plans, poor performance persists across the rail network,” it said.

The committee set out to examine long-promised plans for reform of the UK rail network, originally prompted by the system’s collapse in 2018 owing to a chaotic timetable rollout.

The resulting “Williams rail review” led to a government white paper in 2021, which outlined plans for GBR.

That new body would oversee the highly complex sector, which currently has responsibilities split across different public and private bodies, as well as between the Department for Transport and the Treasury at government level.

But GBR has yet to be fully established after legislation was set back following a change of prime ministers in autumn 2022, meaning £1.5bn a year in associated cost savings has also been delayed.

“It has been six years since the department identified the need for a root and branch review of the railway, but it has achieved very little in this time,” the committee said.

The report said legislative delays were only one part of the reason, however, noting that “from the outset” the Treasury and DfT had disagreed about the extent of GBR’s intended responsibilities, including who should set fares in the future.

It also found that changes to the state’s financial model for the railways, introduced during the Covid-19 pandemic, had resulted in the two ministries holding different priorities.

While the DfT was aware that it needed to “increase revenues and reduce costs”, said the report, its focus was on managing costs, while revenue now goes directly to the Treasury, along with the risk for any shortfalls.

“This means that the department, train operating companies and HM Treasury have different priorities when making decisions which impact revenue, and the current set-up does not create the right incentives to get the best value for money for taxpayers,” it said.

The report noted that 13.7 per cent of trains were delayed in 2022-23 and 3.8 per cent were cancelled.

The DfT declined to comment owing to political restrictions during the general election campaign.

FT : taly’s amnesties damage the economy as well as the rule of law

taly’s amnesties damage the economy as well as the rule of law

Giorgia Meloni’s government is following a well-trodden path by tolerating lawbreaking in the construction business

Last Friday Italy’s government decreed an amnesty for illegal construction. Parliament is expected to ratify the decree, which could affect millions of buildings and homes, and even to extend it to cover 150 legally dubious restructuring projects in Milan. The amnesty exemplifies Italy’s enduring leniency towards mass lawbreaking. This attitude now threatens to hurt Italy’s post-pandemic recovery plan, funded mostly by the EU, and the effort to reverse the country’s decades-long economic decline.

Productivity has stagnated since the 1990s chiefly because Italian firms are on average too small and too slow to grow. The few firms that employ more than 50 workers are comparatively productive, the myriad smaller ones far less so. One explanation is that domestic competitive pressures are relatively low, especially in services. Stronger competition would help innovative Italian firms and push weaker ones out of the market. Another explanation is the weakness of the rule of law, which hinders innovation, the growth of firms and efficient allocation of resources. Tax evasion, for example, can save underperforming firms from failure.

The structure of Italy’s recovery plan — conceived by Mario Draghi’s technocratic cabinet in 2021, and revised by Prime Minister Giorgia Meloni’s government last year — reflects this analysis. Its key reforms, presented as critical for productivity growth and efficient investment of the funds, concern competition policy and three sectors that directly affect the quality of the rule of law: the justice system, public administration and business regulations.

These four reforms were designed by Draghi’s cabinet. Meloni’s dragged its feet on competition policy, to protect special interests as petty as beach operators. This attracted official rebukes from President Sergio Mattarella. But the relevant EU milestones have nonetheless been met.

To succeed, however, Draghi’s reforms must change the behaviour of millions of firms and citizens. In the past, other ambitious measures fell short precisely because they were not perceived as credible. By further weakening the rule of law, a policy of tolerance for lawbreaking may contribute to crippling the latest four reforms as well.

Urban and territorial planning policy offers an example. After 1985 reforms were often accompanied by amnesties for illegal construction. Disfigured Italian towns, valleys and coastlines display the consequences.

The repeated combination of reforms and amnesties had similar effects on tax evasion. The gap between theoretical and actual VAT revenue, which is comparable across the EU, is between 6.9 and 8.8 per cent in France, Germany and Spain. In Italy it reaches 21.3 per cent. Among small entrepreneurs, professionals and the self-employed, Italy’s income tax gap exceeds 68.3 per cent.

These so-called taxpayers, numbering about 2.6mn, are a subset of those generally unproductive small firms. Among them are many of the interest groups that have tended to support the right since Silvio Berlusconi entered politics in 1994, and have benefited from frequent tax evasion amnesties. Predictably, Meloni’s government issued one in 2022 and one in 2023.

In fairness, the problem is older (the first amnesty was in 1973), and is not confined to the right (Matteo Renzi’s centre-left government also sinned). But these latest amnesties, coupled with other lenient policies, do not simply fail to break that vicious circle. By weakening the credibility of official priorities, and of the law itself, they undermine a reform-and-investment plan that could appreciably raise long-term growth — in an economy that at last shows encouraging, if fragile, signs of vitality.

Italy is now debating Meloni’s plans for constitutional reform. A higher priority is the rule of law, an essential function of the state. Her government should strengthen it, not weaken it.

>>> Starting from tomorrow, May 28th, the US SEC will require all broker-dealers

Starting from tomorrow, May 28th, the US SEC will require all broker-dealers and other market participants to settle trades on a T+1 basis

- Since 2017, the settlement cycle – the time between the transaction date and the settlement date – for most securities transactions has been two business days – often referred to as “T+2.” Under “T+2,” if you sold shares of ABC stock on Monday, the transaction would settle on Wednesday.

- T+1 settlement, also known as same-day settlement, refers to the process of settling trades on the same day they are executed, rather than the traditional T+2 (trade date plus two days) cycle.

- Market participants, including broker-dealers, clearinghouses, and custodians, will need to adapt to the new T+1 settlement cycle.

- means that trades will be settled and cleared on the same day they are made, reducing the time it takes for investors to access their funds and securities.

- This change aims to improve market efficiency, reduce risk, and provide better access to capital for investors

**Link: https://www.sec.gov/oiea/investor-alerts-and-bulletins/new-t1-settlement-cycle-what-investors-need-know-investor

WSJ : China Raises $48 Billion for Semiconductor Fund to Bolster Chip-Making Cap

China Raises $48 Billion for Semiconductor Fund to Bolster Chip-Making Capabilities

Funding comes in the wake of U.S. efforts to restrict China’s access to advanced semiconductors and chip-manufacturing equipment

SINGAPORE—China raised about $48 billion in its third installment of a national semiconductor fund, aiming to increase its chip-making capabilities in the face of an escalating technology competition with the U.S.

This latest financing round is the largest for the state-owned National Integrated Circuit Industry Investment Fund, created in 2014. Commonly known as the “Big Fund,” it directs state support to build up the country’s semiconductor supply chain and has played an outsize role in its development.

The third tranche of the fund, which was registered on Friday, counts China’s Ministry of Finance as its largest investor and has attracted funding from the country’s biggest state-owned banks and investment vehicles linked to local governments such as Shanghai, Beijing and Shenzhen. It hasn’t yet released any investment plans.

Beijing’s national efforts to wean itself off foreign technology have been turbocharged over the past years, as U.S. authorities increasingly cut China’s access to American technology and know-how. Chinese leader Xi Jinping is seeking self-sufficiency in critical technology such as semiconductors and jet fighters to the production of grain and oilseeds.

Governments across the world are pouring billions of dollars into nurturing domestic semiconductor industries as a boom in artificial intelligence drives demand for advanced chips, and after the pandemic laid bare supply-chain constraints.

The U.S. earmarked more than $50 billion to expand chip manufacturing and research at home. South Korea, home to chip makers Samsung Electronics and SK Hynix, announced a $19 billion tax-incentive this month to bolster its semiconductor sector.

In the past, China’s government semiconductor fund has concentrated its investments in areas that buttressed the country’s overall chip-making capabilities.

Bernstein analyst Qingyuan Lin said manufacturing would remain the main focus of fund allocation this time, as it requires the biggest financial investment. Other analysts say the money is expected to promote technological advancements in sophisticated chip-making technologies, such as advanced high-bandwidth memory chips, an area where China currently has no production capabilities.

The fund raised about 138.7 billion yuan—about $19 billion based on today’s exchange rate—from entities like the central government, banks and companies during its first phase. It raised another 204.2 billion yuan—or around $28 billion—in a fresh round in 2019.

China offers a broad mechanism of support for the chip sector, including government grants, tax breaks, equity investments and low-interest loans.

Such state support has already resulted in the growth of a burgeoning chip industry in China, primarily in older technology chips that are widely used in automobiles and other electronics. Research consulting firm Gavekal Dragonomics said China is bolstering its chip-making capacity in such legacy chips, and will add more production capacity than the rest of the world combined in 2024.

Government funds also supported the development of Chinese companies specializing in chip-making equipment and materials helping them win market share.

“Beijing is now more confident China will make meaningful progress on semiconductors. Otherwise, they wouldn’t have raised more money this time around,” said Linghao Bao, a senior analyst at research firm Trivium China. Bao said U.S. export controls created a tailwind for Chinese companies to succeed, as more local chip foundries—firms that produce chips designed by others—are willing to adopt domestic alternatives.

The Ministry of Finance holds about 17%, the largest share in the latest third tranche, according to Tianyancha, a company registration database.

China’s biggest banks, including the Industrial & Commercial Bank of China and China Construction Bank, said in filings to the Hong Kong stock exchange on Monday that the fund had an investment focus on “the full industrial chain of integrated circuit.”

China’s efforts to incubate its chip industry with state capital have helped companies grow but also resulted in corruption and waste. A former top executive at the fund was probed by China’s anticorruption agency in 2022. The fund didn’t respond to a request for comment. Some Chinese companies meant to produce sophisticated chips went belly-up after burning through massive amounts of state funding, illustrating the challenges Beijing faces.

(Makor) ALO FP Rights issue

ALO FP Rights issue

ALO announced today the terms of its €1bn rights issue.

Find below the usual one pager as well as our calculations on valuation post.

We remind investors of the terms and results of ALO's rights issue back in November 2020:

1/ Summary One-pager

We believe the situation and the various commitments are different this time around.

We expect the initial subscription rate to be 98% and the pro-rate to be around 5%.

2/ ALO's valuation post rights issue

If ALO trades back at a 15% discount to SIE's current PEs, ALO should be trading in a €19.0-21.7 range

If ALO trades at a 20% discount to SIE's current PEs, ALO should be trading in a €17.8-20.4 range

3/ Shareholding structure (March 31, 2024)

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WSJ : Wood Group Knocks Back Sweetened $1.93 Billion Bid from Sidara

Wood Group Knocks Back Sweetened $1.93 Billion Bid from Sidara

The Scottish energy-services provider said the offer of 220 pence a share significantly undervalues the company and its growth prospects

John Wood Group WG 5.17%increase; green up pointing triangle rejected an improved 1.52 billion-pound ($1.93 billion) takeover bid from Sidara, following two prior proposals by the Dubai group.

The Scottish energy-services provider said Friday that the offer of 220 pence a share significantly undervalues the company and its growth prospects.

The bid, which represents a 3.8% increase on the prior offer, was rejected on Thursday. It followed a GBP1.47 billion approach made public May 15. The initial bid, disclosed May 8, valued Wood Group at GBP1.42 billion.

Sidara has until June 5 to either make a formal offer for Wood Group or walk away under U.K. takeover rules.

The interest comes about a year after Apollo Global Management walked away from a possible takeover of Wood Group, offering 240 pence a share.

Sidara, formerly known as Dar Group, is owned by Dar Al-Handasah Consultants Shair and partners.

>>> Europe : Brokers Upgrades & Downgrades - 27th of May 2024 V3(++)

>>> Up

* Autoliv GDRs Raised to Buy at Handelsbanken (+)

* Bouvet Raised to Hold at Arctic Securities; PT 68 kroner
* Ceconomy Raised to Add at Baader Helvea; PT 3.40 euros

* Galenica Raised to Buy at Research Partners; PT 84 Swiss francs (+)

* Leroy Raised to Buy at Arctic Securities; PT 60 kroner

* Osmosun Raised to Hold at TP ICAP Midcap; PT 6.60 euros (+)

* RAI Way Raised to Buy at Equita; PT 6.60 euros (++)

* SNP Schneider-Neureither Raised to Buy at M.M. Warburg (+)

* Streamwide Raised to Buy at TP ICAP Midcap; PT 29 euros (+)

>>> Down

* Bachem Cut to Hold at Octavian; PT 88 Swiss francs (+)

* Clas Ohlson Cut to Hold at Handelsbanken (+)

* Gentili Mosconi Cut to Hold at TP ICAP Midcap; PT 3.50 euros (+)
* Ionos Cut to Equal-Weight at Morgan Stanley; PT 26.10 euros

* Lepermislibre Cut to Hold at TP ICAP Midcap; PT 1 euro (+)

* Webstep Cut to Hold at Arctic Securities; PT 26 kroner

>>> Initiation

* Genova Property Rated New Buy at Arctic Securities; PT 62 kronor
* Millicom Rated New Overweight at JPMorgan; PT $30

>>> Call

* Ionos Loses All-Buy Status as Morgan Stanley Sees Risks Ahead (++)
* Julius Baer Buying EFG Would Raise Questions Over Strategy: RBC (+)

* Suess MicroTec Falls After MWB Cuts to Hold on Fair Valuation (++)

FT : The valuation mystery

The valuation mystery

Something happened to the valuation of US stocks about thirty years ago. Take, just for one example, Robert Shiller’s cyclically adjusted PE ratio (the S&P 500’s price divided by its 10-year average earnings). Through 1995 it looked like a well-behaved mean reverting series, where the mean was about 15. Since then it has looked like a somewhat more volatile but still mostly mean reverting series where the mean is about 28:

If you think valuations are an important if imprecise indicator of long-term returns (as I do) this is important, and vexing. Even if you are prepared to accept that something about valuations changed thirty years ago (as many value investors struggle to do) the fact that it changed demands an explanation. If you don’t understand this, how can you know that another change is not approaching, or is not already here? Granting there is a statistical relationship between valuations and long-term returns (some think there isn’t), if you don’t understand why the relationship changes through time, it would be foolhardy to use it for decision making.

I have been thinking about this problem without coming to any particularly firm or useful conclusion for an embarrassingly long time.

My best guess used to be that what changed was inflation. When valuations were lower, inflation was generally higher and, what’s more important, less stable. Equities are often thought of as an inflation hedge, but this is only partly true. High and unstable inflation (and all high inflation is unstable) makes life difficult for companies, dampens real growth over time, and can contribute to recessions. It makes sense that persistently higher inflation should be associated with lower equity valuations. Unfortunately for this theory, we’ve just had the biggest inflation spike in 40 years and valuations have only gone up. That does not mean that we need to dump the idea altogether. Inflation expectations have remained generally under control over the past few years, and for valuations it is almost certainly expectations that matter, because stocks are such a long-duration asset. Still, 10-year inflation expectations on the Cleveland Fed’s model were around 2 per cent pre-pandemic and they are around 2.5 per cent now, and valuations don’t care a bit.

Another possibility is that the last several decades have just been really strange. They have featured two epic bubbles, a once-in-a-lifetime financial crisis, a revolution in monetary policy and a global pandemic. Maybe it would be unrealistic to expect any market regularities to hold in such a whirlwind, and old patterns will reassert themselves eventually. There could be something to this, but looking at a 30-year period and declaring it anomalous is a little more than the social scientist in me can bear.

Shiller himself was bothered that for many years his Cape ratio has been very high while stocks rose ever higher. His solution was to adjust for interest rates. His “excess Cape yield” (ECY) is the reciprocal of the Cape multiple, expressed as a percentage, less the real return on 10-year Treasuries. As it is a yield rather than a multiple, a higher ECY means stocks are cheaper. And historically, the ECY does seem to do a pretty good job of signalling good and bad times to buy equities. That said, while at the time Shiller first introduced the ECY in 2020, it did make the S&P 500 look more reasonably priced than the classic Cape ratio, it no longer does, because rates have risen sharply and stock prices have risen too. Just like with the Cape, there are quite distinct pre- and post-90s ECY regimes. Before, the average ECY was about five per cent; now it is half that level (and right now, the ECY is at a revolting 1.2 per cent).

In a recent post the blogger and former equity strategist Jim Paulsen offered five interesting explanations for the shift in the Cape ratio:

Economic cycles have become more gentle: “From 1854 to WWII, the US was in recession 42 per cent of the time. Since 1980, it has had recessions only 11 per cent of the time. Arguably, when one of the biggest risks for stock investors, recessions, occur less frequently, valuations can and should expand.”
The composition of the market has changed, with faster-growing technology companies making up a bigger part of it: “Since the 1980s, the US has enjoyed a rapid pace of modernisation including fiber optics, mobile phones, the PC, the internet, social media, streaming services, and now AI . . . innovations have always received higher multiples as much of their value is based on future business growth . . . growth stocks have always received higher PE multiples compared to cyclical stocks.”
The market is more liquid now: “Not only has individual [market] participation improved substantially, but international investors have also expanded. Technology advances have also improved liquidity as electronic trading now makes investing so much easier. Similar to any individual stock, when liquidity improves, volatility diminishes, and valuations rise.”
“Profit productivity,” or real profit per worker, has risen. “Since 1940, there has been a close relationship — a correlation of +0.69 — between the stock market’s PE multiple and profit productivity. What is most striking about this relationship is when the stock market was in its old stable valuation range, profit productivity was also in a stable range. When profit productivity broke this range in 1990 and surged higher ever since, the valuation of the stock market also broke its old valuation range and remained higher.”

I think the first two ideas are compelling and interesting, and the third and fourth are not. Starting with the bits I disagree with, I can’t see how the difference in liquidity between now and 30 years ago is enough to explain a significant move in average valuations. Stocks are more liquid now, but you did have daily liquidity back then, and on very bad days — the days that really matter — liquidity is still a problem today. Also, it is worth noting that low-liquidity assets — private equity and debt — do not trade at much of a discount in today’s market.

On productivity, I agree with Paulson that productivity is the most important thing, in the sense that it is the most important driver of growth, for both economies and businesses. From an investor’s point of view, however, what matters is profit levels and profit growth, not their drivers. At best, an explanation of valuations based on higher productivity is reducible to an explanation based on higher growth. If productivity growth is good for valuations, it is because it means higher growth rates.

This leads us to Paulsen’s second point, that the market contains more growth stocks now. This explanation makes broad sense, but it makes me somewhat nervous, because I think growth rates are very hard to predict. Higher future growth in profits must, all else equal, be reflected in a higher valuation, if asset prices are the present value of future cash flows. And if we look at the current crop of huge, dominant growth companies and their powerful market positions it is easy to think that their growth rates will persist. History teaches us, however, that dominant positions in markets, including tech markets, can disappear rather quickly (General Electric, IBM, Nokia, et al). It may be that today’s tech companies enjoy semi-permanent “increasing return to scale” dynamics that will help their growth persist for longer than past companies’. But I’m just not sure.

This leaves Paulsen’s final point, that the economy is more cyclical now. I agree with Paulsen’s instinct that the very worst economic moments are the ones that matter most for investors. It is in recessions when companies are most likely to fail, when margin calls tend to happen, and when panic selling wipes out portfolios. But, again, have the last 30 years, with its bubbles and busts, really been so calm — calm enough to justify a doubling of valuations? Perhaps modern central banking has taken the hardest edges off the economic cycle, but again, I’m just not sure.

Valuation matters. The idea that what price you pay for a financial asset does not matter to the future returns from that asset is a non-starter. But how to best measure valuations, and how to best deploy those measurements in decision making, remains a very tricky question.

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