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Ashwath Damodaran’s warning to stock market investors

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Finance professor and valuation guru Ashwath Damodaran believes that if investors underestimate expected long-term inflation, as they did in the 1970s, we expect a long period of malaise on the steps.

Investors expect inflation to peak over the next year and decline over the longer term, to levels close to levels seen over the past decade. This is perhaps a hopeful thought, and stock and bond returns over the rest of the decade will be determined by the accuracy of this assessment; if investors underestimate expected long-term inflation, as they did in the 1970s, we are going to have a long period of market malaise,” he said on his blog Monday.

While Damodaran said he remains skeptical of inverted yield curves as inescapable predictors of recessions, the message in the yield curve distortions on September 23, 2022 is not positive about the future of lending. ‘economy.

The first- and second-order effects of inflation have been large and damaging, but the question that remains unanswered concerns the long-term effects on the economy and, more importantly, on the psyche of investors and consumers.

After spending all of 2022 trying to achieve a rolling target on expected inflation and the resulting interest rate, the only guarantee for the future is that more changes are to come. To pass judgment on direction, we have no choice but to take a position on where inflation will take hold once supply chains are fixed, COVID is a thing of the past and maybe after the economy cools. If we go back to 1-2% inflation, as the market seems to believe, we will face a very different endgame than if we go back to 1980s levels of 3-4%,” he said. added.

If one is bullish, the assumption that makes the biggest difference is where you see equity risk premia converging, with premia closer to 4% causing the index to be undervalued, even with large earnings shocks embedded, according to Damodaran.

At the other end of the spectrum, if the equity risk premium remains at 6% or more, the only scenario where we arrive at a value close to the index is if the 10-year T.Bond rate drops to 2% and earnings estimates are coming in as expected, with significant corrections to come, he explained.

Given the choice between letting inflation happen and initiating policies that trigger a recession, some are pushing for the former, arguing that it is no good trading the certain pain that comes with a recession for the uncertain benefits. lower inflation. Politics. High and volatile inflation corrodes economies and markets from within, destroying confidence in currencies and causing investors and businesses to behave dysfunctionally,” he added.

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