The Stock-Bond Disconnect

CAMBRIDGE – How should one understand the disconnect between the new highs reached by global equity indices and the new depths plumbed by real interest rates worldwide? Several competing explanations attempt to reconcile these trends, and getting it right is essential for calibrating monetary and fiscal policy appropriately.

The most popular explanations downplay risk factors in a way that can be dangerously misleading. For example, the “secular stagnation" theory claims that low interest rates tell the true story. The global economy is suffering from a chronic demand shortfall, which can be remedied through sustained growth in government spending.

According to this view, soaring stock markets merely reflect low discounting of future profits. Moreover, labor's share of profits seems to have fallen markedly in recent decades across the world's eight largest economies, with the possible exception of the United Kingdom. Conversely, capital's share of profits has been rising, which of course raises the value of equities (though, stock prices have continued to rise in countries like the US and the UK where labor shares have begun at least a cyclical recovery, and where interest-rate hikes may soon be on the horizon).

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