(1/8) An interesting thread from @TheMarketDog on looking at current valuations of stocks versus historical precedents. They are undeniably at very high valuations. However, these valuations unfortunately do not translate to real growth & wealth creation. https://twitter.com/TheMarketDog/status/1357918284100763654

(2/8) Stock prices represent a history of transactions, which involve buyers and sellers. Valuations are derived by taking the last transaction price and multiplying by all shares. A small # of irrational buyers can cause wild valuations which is why valuations can be misleading.

(3/8) e.g., If you have 10 slices of pizza and I am willing to buy only 1 slice for $100, is that pizza worth $1000? No. You have one idiot (me) willing to buy 1 slice at $100 and 9 slices of pizza, because the other 9 slices will not clear at a market price of $100.

(4/8) Valuations matter to the extent they can be translated from the financial economy to the real economy. You cannot eat stocks, live in stocks, or drive stocks to work. The primary mechanisms for financial > real economy is through equity raises, collateral markets, & sales.

(5/8) Companies can create new shares to sell and receive cash in return. They then use this cash to invest in the real economy. Asset holders could pledge shares as collateral for loans to be used in the real economy (though is often used to lever up more in financial markets).

(6/8) Stocks have an inelastic dynamic that affects the efficiency of transfer from the financial econ to the real econ. Gabaix & Koijen have estimated that $1 into stocks causes a $5 increase in valuation. Which impacts on the way up and on the way down.

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3686935

(7/8) Stocks with sky high valuations are disproportionately well capitalized companies that are buying back shares and do not need equity raises (e.g., FAANG). Pledging shares for loans is common for levering up within fin markets (margin) but not for investing in the real econ.

(8/8) Inelasticity of markets impedes an efficient transfer of capital from the fin markets to the real econ. If we were to sell en masse, values would crater fast. The stock market is not the economy and is increasingly not serving its purpose of efficiently allocating capital.

If you would like to learn more about the inelasticity of markets and the impact of changes in the set of buyers and sellers (i.e., passive vs. active) I would recommend you see @profplum99's work at Logica.