Economics made simple, very simple.


Here is today’s chart of the day. Any student of has , at some point in their lives , come across the “discounted cash-flow” concept. In its most simplistic form it states that a stream of income in the future has a value today (PV) equal to that stream adjusted by the discount factor. Given that few market participants look further than 10 years , that rate is a reasonable proxy for the discount rate. The math, for those of you who were not wholeheartedly attracted to calculus, limits and other such wonderful concepts, can also be simplified. We get PV= Stream/ 10year rate. Using the US government 10 year note, 2% just a month or so ago we had PV=100/2= 50 (notice that when rates drop to zero, the value of anything and everything starts to approach infinity – a phenomenon either very well understood by the FED or not at all. Now with the 10 year at about 3% and earnings at 40 we get, PV=40/3=13.3. Simplifying the math tends to take out the compounding and therefore exaggerates the result, lets call it 20. From 50 to 20 is a drop of 60% (do I detect the invisible hand of Fibonacci, that guy from Pisa?). Applying that to the S&P which topped at 1576 gives us 630; we are at 860 today! This , of course , assumes that profits do not drop further and or rates do not rise more.