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- Manlobbi
Stocks A to Z / Stocks B / Berkshire Hathaway (BRK.A) ❤
No. of Recommendations: 3
There was an interesting thread over at Bogleheads on ERP. I know many here wouldn't darken their door :-)
WaPo:
https://archive.ph/UHPLkThe so-called equity risk premium—or the gap between the S&P 500's earnings yield and that of 10-year Treasurys—shrank to close to zero this week, the lowest level since 2002, according to Dow Jones Market Data.ERP at zero?
Aswath Damodaran thinks differently?
How to calculate:
https://papers.ssrn.com/sol3/papers.cfm?abstract_i...Takes expected growth into account.
Latest:
https://pages.stern.nyu.edu/~adamodar/Implied ERP on November 1, 2024=
4.04% (Trailing 12 month, with adjusted payout);
4.29% (Trailing 12 month cash yield);
6.19% (Average CF yield last 10 years);
4.17% (Net cash yield);
3.90% (Normalized Earnings & Payout)
4% ain't so bad?
No. of Recommendations: 1
TUDR 😬
Man he wasn't kidding about the ugly website!
No. of Recommendations: 29
The so-called equity risk premium—or the gap between the S&P 500's earnings yield and that of 10-year Treasurys—
Hmm. First, that isn't what the equity risk premium is.
Second, that isn't how you'd calculate it.
But more importantly:
Anyone thinking that it's meaningful to compare those two quantities directly should first read "Fight the Fed Model", a lovely paper rousoundingly debunking the myth, from over 20 years ago. In short, prevailing nominal bond interest rates at the time of purchase of equities have no bearing at all on your return from the equities, neither theoretically nor empirically. What *does* matter is the valuation level of the equities at the time of purchase, regardless of whether interest rates were high or low at the time. Well, yeah.
Jim
No. of Recommendations: 1
TUDR 😬
Man he wasn't kidding about the ugly website!Have you ever visited the Berkshire Hathaway corporate website?
https://berkshirehathaway.com/It is functional and easy to navigate. Not pretty.
No. of Recommendations: 6
The so-called equity risk premium—or the gap between the S&P 500's earnings yield and that of 10-year Treasurys—
Hmm. First, that isn't what the equity risk premium is.
Yes. We should tell the WSJ (I mistakenly wrote WaPo in the OP).
Second, that isn't how you'd calculate it.
Hence me posting the Damodaran paper.
In short, prevailing nominal bond interest rates at the time of purchase of equities have no bearing at all on your return from the equities, neither theoretically nor empirically. What *does* matter is the valuation level of the equities at the time of purchase, regardless of whether interest rates were high or low at the time. Well, yeah.
Don't interest rates affect the valuation? Can ERP be used as an indicator of market valuation?
Here's Buffett, maybe:
"Interest rates are to asset prices like gravity is to the apple. They power everything in the economic universe."
"If interest rates are nothing, values can be almost infinite. If interest rates are extremely high, that's a huge gravitational pull on values."
No. of Recommendations: 9
Here's Buffett, maybe:
"Interest rates are to asset prices like gravity is to the apple. They power everything in the economic universe."
"If interest rates are nothing, values can be almost infinite. If interest rates are extremely high, that's a huge gravitational pull on values."
It's a great quote, but (sorry) it's one of those times, as with trade deficits (aka capital account surpluses), that Mr Buffett is flat out wrong. (if taken too literally)
Prevailing interest rates can certainly (though irrationally) have a strong effect on equity *prices* sometimes. But as I'm sure Mr Buffet would be the first to agree, prices are not the same as values. Value is what you get. Prevailing interest rates do not affect equity values. I think that in most quotes from Mr Buffet about interest rates affecting stock valuations, he would of course agree that his comments are about prices and likely forward market returns, not at all about true value, i.e. future owner earnings.
The value of an equity is a function of its future trajectory of real owner earnings. The existence of current alternatives with higher or lower real returns is not an input to that. If person A is currently willing to pay a million bucks to person B for financial security C, that does not affect the intrinsic value of my equity share D. It might affect the market price of D, or might not, but I still get my claim to owner earnings either way.
Jim
No. of Recommendations: 1
The value of an equity is a function of its future trajectory of real owner earnings. The existence of current alternatives with higher or lower real returns is not an input to that.
The first statement is the first principle of "value" investing, as I understand it. I don't understand the second statement, if the question is where to pursue value. But I agree that current or prospective interest rates should not matter to the choice.
Buffett's comments do point to some sort of relationship between interest rates, value, and prices, though; and I think it is true that the elasticity of that relationship is one reason why value is not always accurately reflected in price.
Baltassar
No. of Recommendations: 7
Buffett's comments do point to some sort of relationship between interest rates, value, and prices, though; and I think it is true that the elasticity of that relationship is one reason why value is not always accurately reflected in price.
For sure. Currently prevailing interest rates (whether rationally or not) certainly affect asset valuations much of the time, largely on the competing asset theory, but also because many buyers are irrational sometimes.
I merely assert that interest rates don't affect the *value* of equities, only perhaps the prices. Once the clouds and storms of current interest rates pass, whatever real earnings were to come will still be there.
e.g., the average US cyclically adjusted equity earnings yield in the summer of 1982 was about 16% and was in effect entirely inflation protected---the high interest rates of the day didn't make that worth nothing. Indeed, they were perhaps a buying signal: with anomalously high nominal interest rates you tend to see (irrationally) anomalously cheap equity valuations like that.
Admittedly there is some meaning to the observation at the margin, but it's the tail, not the dog. If companies have a lot of debt and their real (not nominal) interest rates go up as they roll debts over, their real earnings will take a hit. But this true hit is tiny compared to the price swings you see all the time.
Jim
No. of Recommendations: 2
“I merely assert that interest rates don't affect the *value* of equities, only perhaps the prices. Once the clouds and storms of current interest rates pass, whatever real earnings were to come will still be there.”
Superb lesson hammered home by Jim & others here that made it a lot easier for a lot of us to Add 2 years ago, despite up to 9% inflation in 2022 and not be concerned about the lengthy 5.5% Fed rate & looking at the horizon at the real earnings to be harvested over many many years.
No. of Recommendations: 4
One of Jim's best concepts is the inflation/earnings over time one. I'll not try to re-state it as my wording wouldn't pass the edit, but it is related to WEBspired's post that this replies to.
No. of Recommendations: 9
The value of an equity is a function of its future trajectory of real owner earnings.
Agreed. But what are these future earnings worth now? I hope you agree that they need to be discounted back to present using an appropriate discount rate.
Money I have now can be invested in treasury bonds that earn near risk-free interest. It seems logical that future earnings are worth less if interest rates are high, as I can earn more interest between now and when these earnings arrive with money I already have. If interest rates are super-low, the value of future earnings is very close to money that I hold now, so the discount rate shall be low.
IMHO Buffett is very right that low interest rates drive up *values* (and vice versa), as discount rates must take the interest environment into account.
No. of Recommendations: 16
But what are these future earnings worth now? I hope you agree that they need to be discounted back to present using an appropriate discount rate.
This is an interesting discussion. I spent a fair bit of my career calculating the "Net Present Value" of known oil reserves in the ground. The amount of oil in the ground would not change, but the discount rate used drastically affected the value of it. You can't just pick up the oil and sell it, you have to invest in drilling and production facilities, then wait as it dribbles out over the life of the wells. The exact same amount oil in the ground that would be profitable to produce during a time of low discount rates would be have no value in a high interest rate environment.
