How to invest when interest rates are low and stock markets are high?


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Government bonds: rate risk is not a joke with ten-year rate around 1.9 % and shorter return practically invisible. What about stock markets? After 6 years of bull market S&P 500’s yield is less than 2% (median since 1870: 4.35%) and its PE ratio is 20.5 (median since 1870: 14.5). We all know what is justifying and sustaining sock market valuation level, but the effect has already gone a long way and it can only go so far. Expectations are now meager as over the long term as there is no place else for bills, bonds and liquidity to go than down. You can hand-pick markets: how about Russia, Greece right now? It is not enough to make an investment strategy. And you have alternative investments. Private equity, as an asset class, actually returns around 15% on average, but with two caveats: first there is a large variance in returns, so if you cannot afford to largely spread your bets you actually are participating in a lottery. Second, you actually lose a big chunk, let’s say 25%, of the overall return due to fees and vested interest, and this loss is not compensated by a decrease in risk. As a result the risk-return of PE (Sharpe style) is far less attractive than it seems. The same can be said for hedge funds, especially in these times of low rates. Only it is worse as they have incentives for taking as much risk as possible in order to maximize managers’ compensations when it works, while they don’t give back anything when they loose their investors’ money. And there is always that moment. Then you have art, various collectibles, and wines. The prices in these classes are only based on the purchase power of those who covet them. They are a reflection of the high liquidity economy and, again, of the ridiculous level, in an historical perspective, of rates. There will be blood on these markets. Finally, real estate. What I like in real estate in our era is getting at the same time a very high yield-far better than HY bonds funds-and having this yield protected against inflation. If prices go up, so do rents. Granted, if rates go up and rents don't do as much, the value of the income-producing asset can be affected, but 1) there is no free lunch anyway and 2) real estate comes with a free option value related to the likely land appreciation over time, as demographics is the less unpredictable variable we have to deal with in this world. Investors should increase their real estate exposure now in well-chosen locations with yields between 7-9% and ROE around 15% over 10 years, all other things being equal.


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