I think I was not alone yesterday in looking at the big blob of money wandering around. At one point it looked like the market was going to be broadly down, because the options are depressing. As the blob of money lumbers out of tech and into not tech, valuations wind up rich, especially given rates. Here’s a way to look at it. Take a company that has about a 3% real long term return through a combination of price appreciation and re-invested dividends. I say “real” to mean inflation adjusted. That means every 24 years, or so, you double your money in real terms. The nominal (or not inflation adjusted) rate of return might be 5% (assuming a 2% rate of inflation).

You could also buy bonds, which might be paying 2% in real terms. (The nominal rate is 4% but there’s 2% inflation). If you reinvest the dividend, you double your money in real terms in 36 years. But the bond is considered near zero risk (given the time horizon) while the stock may or may not pan out. Even a very stable business with a simple and straightforward revenue model may not survive all 24 years. Or, like GM, it may stumble repeatedly. 10 years of bad management and shrinking margins may seriously undermine your 24 year plan. The stock has more risk than the bond (which does have interest rate and reinvestment risk – but we’re eliminating interest rate risk by holding to maturity and assume the the reinvestment risk averages to zero over 36 years).

One way to look at the double your money equation is to say you bought the company for cash, today. Every share. How long would it take to make that money back? Well, your money doubles, in real terms, in 24 years. That means it will take 24 years to make your money back. The company earnings are what provide the price appreciation and dividends (although stock buy-backs are seen by stupid investors as more tax efficient). So how much would you pay for one year of that company’s earnings? It’s simple, 24 times. At that rate you should have accumulated enough to buy the company outright in real terms.

That leads to a fairly simple model of how to anticipate the change in value of the company, given the interest rate. If the nominal interest rate goes down to 3% (but holding inflation at 2%), then we would be willing to pay more for that company. Why? Because it would now take 72 years to double our money with the bond versus 24 years for the company. While the company has more risk, it is is more attractive and we would be willing to pay maybe 36 times earnings. We’re taking higher risk, but more reward than the zero risk option. Likewise, if nominal interest rates go up to 5%, and it now takes us only 24 years to double our money with bonds, the company looks less attractive. It’s worth maybe 12 times earnings, for the given level of risk.

That’s the “perfect world,” thought experiment view of valuing a company. The giant ball of money screws with that by suddenly injecting a ton of buying into that company. CNBC and influencers talk about the massive run up in the company. Other idiots then try to follow the trend. That company should be trading 24 times earnings long term, but the ball of money pushes it to 30 and the idiots help drive it to 35. Retail investors get sucked in because “this time it’s different.” Retail investors are left holding the back when the ball of money chases the new shiny thing. The smart money that owns much of the ball gets out at 35. Retail investors ride it down from 35 times earnings to some over-correction down to 18 time earnings, essentially turning over their wealth to the great ball of money.

Which brings us to the ADP report. Is the ADP report an accurate gauge of employment. Not especially. It is a little erratic. But if we look at it over the last few months, we see it’s trending down. And most of the delta between the expected value and the reported value surprised to the down side. The former is consistent with a slowing job market hypothesis and the latter is consistent with most professionals being over-optimistic about conditions. But the picture is cloudy, not clear. We have the Schrodinger’s job market, that’s both good and bad at the same time depending on which number you look at. And that also feeds in to conflicting data, such as manufacturing in the US expanding, but not manufacturing employment.

There is no one number that tells you how the economy is doing. There is no set of numbers that tell you how the economy is doing. In truth, we’ve had a lot of change and I think some numbers, like first time unemployment claims, are no longer indicative of much. While I used to write off ADP as only useful to get journalists on TV hot and bothered when it dropped a wild number, the government jobs number has had a series of issues with major restatements. Companies (for whatever reason – but in this day and age it could be ideological) are failing to report on time, requiring the economists to produce a less accurate estimate. It has never felt so hard to get a bead on the economy.

[Update] Services PMI came in as inflationary to me. Although employment continues to grow in services (which is much larger than manufacturing). New orders are still growing, but slower.