Although the valuations of many assets are higher than their long-run averages, we don’t think sharp falls in their prices are likely. This is because we believe their equilibrium valuations have risen. In our view, the proximate cause of higher equilibrium asset valuations has been a decline in equilibrium real interest rates, stemming from slower potential economic growth, an increase in the desire to save and a decrease in the desire to invest. This decline can be seen in the 500bp-odd drop in advanced economy measures of real, long-term, government bond yields over the past three decades. Lower government bond yields have in turn reduced required real returns on a broader array of assets.
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