Vol. 2, No. 23
Vol. 2, No. 23
The S&P 500 is fairly valued. Antipodean stocks have been boosted by the strong US dollar. Central banks are hoovering up money, and inflation will fall. Value in online advertising.
Welcome to Valuabl, a twice-monthly digital newsletter providing rigorous, value-oriented analysis of the forces shaping global capital markets. New here? Learn more
In today’s issue
Cartoon: The Metareverse
Ideas arena (1 minute)
Cost of capital (3 minutes)
Global stocktake (3 minutes)—Paid subscribers only
Credit creation, cause and effects (6 minutes)—Paid subscribers only
Debt cycle monitor (2 minutes)—Paid subscribers only
Rank and file (2 minutes)—Paid subscribers only
Investment idea (16 minutes)—Paid subscribers only
"It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong."
— George Soros
Cartoon: The Metareverse
Ideas arena
Intelligent debate with a global community in subscriber-only discussions.
•••
Top topics from the ideas arena
Cost of capital
Interest rates are finance’s most important yet misunderstood prices. Here’s what happened to the cost of money in the past fortnight.
•••
Stock prices fell last fortnight. The S&P 500, an index of big American companies, dropped 2% to 3,749. Investors added $166bn to global equity markets (see: Global stocktake) as inflation-adjusted interest rates rose. The market has plumbed its recent lows and is down 20% in the past year.
I value the S&P 500 at 3,707, which suggests it is 1% overvalued.
The companies in the index earned $1.8trn after tax in the past year. They paid out $487bn in dividends and $1trn in buybacks and issued $67bn worth of equity. Analysts reckon their earnings will rise to $1.9trn this year and $2trn next.
Government bond prices dropped. Yields, which move the opposite way to prices, rose again as inflation fell. The yield on a ten-year US Treasury bond, a critical variable analysts use to value financial assets, rose 10 basis points (bp) to 4.1%. Investors expect inflation to average 2.4% over the next decade, down 2bp from the rate they expected last fortnight.
Hence, the real interest rate, the difference between yields and expected inflation, rose 12bp to 1.7%. These inflation-adjusted rates rose 2.9 percentage points in the past year and are the highest they’ve been since 2010. This has made it more expensive for companies and households who want to refinance.
Corporate bond prices also fell. Credit spreads, the extra return creditors demand to lend to businesses instead of the government, dropped 9bp to 2%. The spread on these BBB-rated bonds is up 84bp in the past year.
The cost of debt, the annual return lenders expect to make from loans to these companies, rose 1bp to 6.1%. Refinancing costs have more than doubled, up 3.5 percentage points, in the past year. Lenders now charge firms the highest interest rates since 2009.
Equity investors are still more optimistic than bond traders. The equity risk premium (ERP), the extra return investors demand to buy stocks instead of risk-free bonds, jumped 18bp to 5.1%. They’re now 49bp higher than where they were a year ago. Similarly, the cost of equity, the total annual return these investors expect, rose 28bp to 9.2%, 3.2 percentage points higher than last year.
Expected equity returns are around the highest level they’ve been since 2012.
Money talks—it just needs an interpreter
You are at the end of the free portion of Valuabl. Become a paid subscriber to access all issues and investment ideas.