Forum Archive Index - May 2000

["Mark Hubbard" <mhubbard@es.co.nz>]

I'm a bit busy presently, so my apologies now for the following reply being
a bit scattergun; also it only addresses one portion of your post Derek.

Derek wrote:

> I once saw a comparison of risk-premium, expected returns on share price
> etc and the predicted Dow Jones Index. A 1% increase in interest rates, or
a > 1% > increase in risk premium for shares had a disastrous effect on the
DJI.


I've just finished reading a study which surmised that the risk premium
sought in the US, on average, was approx. 6.5% for equities over long term
bonds. The study was over about a 70 year period, and it did not take into
account market volatility.

Putting this in my own words, it would indicate to myself that with the
increase in US interest rates, the squeeze is now really being applied to
the US stock market - the need to clear a 6.5% return over the increasing
interest rate, especially in reflection of the current volatility (which
must be increasing this risk premium for the average investor, perhaps quite
considerably), would make it seem likely that there is still more downside.

I suspect that what this means is (and certainly for myself) that investors
are returning to valuations based on fundamentals - ie, on the present value
of future earnings based on reasonably high discount rates (due to the
higher risk premium) [remember, the higher the discount factor, the lower
the value arising from the earnings stream]. There was a lot of talk for a
while how tech. companies broke down the 'old' valuation models, but, IMHO
(please note that, IMHO) what is now being proven is that valuations based
on earnings will always be relevant (obviously), and investors will leave
the safe shore of this philosophy at their own risk. CISCO is pretty firm
proof of this in the US - even though reporting good results, from memory,
its share price is still going down, probably due to the fact that it still
has a p/e of 190, which means, again from memory, that its revenues will
have to rise to something like equalling half the yearly output of the
developed world to match! (note this earnings figure may not be correct as
it was from a CNNfn article I read about two weeks ago - the point, however,
that the the price was still extremely high given the p/e, is still very
relevant).

Note I am not saying not to invest in tech. firms, indeed, one of my best
equity investments is still the Finsbury Technology UK investment trust,
however, I have chosen, regarding such firms, or, for that matter, any 'old'
economy firm, to wait for actual earnings to be generated before reviewing
likely entry prices for myself to invest at (for the medium to longer term).

Ie, no more Wavenet fiascoes for this investor.

(Oh for the day that my portfolio starts heading upward again!).



----------------------------------------------------------------------------
http://www.sharechat.co.nz/          New Zealand's home for market investors
To remove yourself from this list, please us the form at
http://www.sharechat.co.nz/forum.html.