The Calculus of Value

THE ARGUMENT

Written as a mid-year update to On Bubble Watch, this is the memo in which Marks lays out the whole framework rather than assuming it: value comes from earning power, price is the consensus of subjective opinion, and valuation is nothing but the relationship between the two. Applied to the US market after the tariff round trip, the calculus gives him fundamentals slightly worse than seven months earlier against prices that are higher, which moves his verdict from elevated to worrisome. His response is a graded scale of defensiveness rather than a call, and he places himself near the mild end of it.

What it actually claims

1. He roots value in earning power — the money an asset makes while you own and operate it, which means anything with no cash flow and none in prospect cannot be valued objectively at all — and treats price not as a calculation but as the outcome of a daily tug-of-war between optimists and pessimists. Since fundamentals barely move month to month while prices move constantly, short-run returns come almost entirely from changes in what people are willing to pay.

2. Value pulls on price like a magnet, but only over the long run: prices can go to crazy extremes in either direction, and that capacity is exactly what produces bubbles and crashes. He treats betting on convergence as intellectually sound and betting on it happening soon as dangerous.

3. The starting point of the arithmetic is a market already expensive before the year began, and the historical record of buying at that multiple is the memo’s sharpest single piece of evidence.

   • •the S&P 500’s forward p/e was around 23 toward the end of 2024, significantly above its historical average
   • •J.P. Morgan Asset Management: buying the index at 23 times forward earnings in 1987-2014 produced ten-year average annual returns between plus 2% and minus 2% every time

4. He walks through the year’s round trip to show the calculus moving the wrong way: the tariff shock repriced the fundamental outlook downward, the relief rally more than took it back, and so prices rose while the outlook did not.

   • •declines of up to 10% in the first quarter, with the Nasdaq Composite falling the most
   • •the tariff announcement took the S&P 500 to a level 15% below where it ended 2024
   • •the 10-year Treasury yield got as high as 4½%, up from just over 4% before the announcement
   • •from its April 8 low the index rose 29%, leaving it up 9% for the year to date and 14% above April 1

5. His aside on concentration inverts the usual complaint: the seven biggest names are not what makes the index expensive, because their multiples look defensible against their moats and margins — it is the multiple on everything else that he finds worrisome.

   • •a bit over half of the S&P 500’s 58% two-year total return in 2023-24 came from seven stocks
   • •those seven have grown to about one-third of the index’s total market value
   • •their p/e ratios average roughly 33
   • •the other 493 companies average a p/e of 22, against a mid-teens historical average for the index
   • •Nifty-Fifty stocks were selling at p/e ratios between 60 and 90 in 1969

6. He stacks up the behavioral indicators alongside the multiple, including the credit market, where the compensation for giving up Treasury safety has thinned to near its historical minimum.

   • •the S&P 500 valued at more than 3.3 times sales, an all-time high (Financial Times, July 25, citing Bloomberg)
   • •a Barclays equity-euphoria indicator at twice its normal level, in territory associated with asset bubbles
   • •the ratio of US market capitalization to GDP at an all-time high, and understated because companies stay private longer
   • •yield spreads approaching all-time lows

7. He states the bull case rather than caricaturing it — that today’s index is increasingly made of companies that grow faster, are less cyclical, need less capital to grow and hold stronger moats, and therefore deserve above-average multiples — and grants that the explanation makes complete sense. What he will not do is adjudicate: he says he cannot tell whether the greater error today is falling for "it’s different this time" or failing to notice when it is, and warns that in most new new things far too many companies, often the wrong ones, get treated as winners.

   • •Templeton put it at 20 percent of the time that things really are different; Marks would bet on more than 20 percent today

8. The conclusion is a posture rather than a forecast: overvaluation can never be proved and implies nothing about timing, but he grades defensiveness on a six-step scale running from stopping buying to going short, says it is time for the second step — trimming aggressive holdings in favor of defensive ones — and holds that reaching the three most extreme steps would take a degree of certainty he calls essentially impossible.

   • •the last sustained market correction ended in early 2009, so no one under about 35 has experienced a prolonged bear market

Figures are the author's own, as cited in the memo.

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