Friday, 28 August 2009

some perspectives on long term yields

L: 74% S:85% G: 159% N: -11% ~ $D 0% $G 0% $V 0% $P 0.00%

Firstly a brief description of how the Raven came up with this chart. He uses a simplistic linear regression on log earnings to forecast future earnings applying this to historic data to come up with historic earnings forecasts, from this he calculates a quarterly earnings yield for the SPX500.

There are several interesting points for the Raven that come from this chart. First of all just looking at the most recent moves we can see that we've bounced off the lows in terms of both yields and equity prices. Secondly it appears that we might have turned a corner in terms of yields on financial assets, ie. that we might be starting to move towards a high yield environment, this would be associated with high inflation and a fall in asset prices. The Raven also notes that we're still at a relatively distended valuation gap between bonds and equity.

Inflation can have several causes, depending on your economic religion. The Raven fails to understand the monetarists that are arguing that quantitive easing is going to be the start of hyperinflation, QE is just a swapping of monetary aggregates hoping to increase the velocity of money, they also give zero weighting to the amount of wealth lost by households. He also fails to believe in wage inflation in Asia for some time yet, China has been adding capacity with its fiscal stimulus, there definitely is more capacity. For example the world's biggest shopping mall South China Mall in Dongguan is absolutely empty.

The way that he can imagine inflation coming about in the West would be to see a dramatic rise in Asian currencies. This would then increase import prices and perhaps trigger an increase in western wages, given the huge amount of public sector wages linked to inflation measures it wouldn't take much for that to increase dramatically. It certainley is the path of most pain for the world, the question is what would lead to that dramatic currency revaluation???

Now another question that is on the Raven's beak so to speak is why are UK houseprices rallying? Figures from the land registry show they have risen this month - that doesn't make a lot of sense to the Raven, but then that wouldn't be the first monthly price change in houseprices that he finds irrational and baffling in the UK. It would appear to the Raven that prices still have a decent amount to fall before we're looking at where house prices have bottomed before. The peak in the HBOS index of house prices was £199,612 a frankly insane price at a price to average earnings level of 5.8, house prices bottomed at a p/e of 3.1 after the comparatively small bubble of late 80s (which peaked at 5x). At that bottom multiple we'd see the index at £113,386 which is a peak to trough fall of 43%, or further 29% from here. Caveat Emptor!!!

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