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Re: [sharechat] More on the marrket risk premium

From: "" <>
Date: Mon, 24 May 2004 20:19:42 +1200

Hi Dean,
>I'm still not convinced that your calculation
> of a return of 2.5% percent or so above that obtained from investing
> in a risk free investment (Treasury bills)  is adequate enough return
> for investing in shares at the moment.  

I think it depends on the share.  If you are thinking that all a share has 
to do is decline 2.5% in value and that means any dividend yield you 
are getting will be reduced to bank term deposit rates then I would 
agree with you.  Investing in such a share would be too risky for me 

But lets go to the example of the moment.   Would you not invest in 
WRI at $1.40 because the share price is likely to decline by 2.5% to 
$1.37?    Let's say the long term yield for WRI is based on a dividend 
of 8.5c per share.  That means you have lost 3c per share in capital 
but your gross long term yield is 9.26%.    Would that really be so bad?
Of course the WRI share price might decline by more than 2.5%, but it 
might go up too.

>That risk premium is at the  lower end of the range of overall 
>historic premiums studied in the USA.

I think that there is a certain amount of evidence out there that fixed 
interest investments have performed relatively poorly over the last 80 
years.     Whether you go back to  'war bonds' issued at very low 
interest rates and used by governments to finance WW2 amongst 
other things or fast forward to the 1970s and 1980s when much of the 
real return of investing in fixed interest was destroyed by inflation, the 
result is the same.   I don't believe that equities will necessarily earn 
the same premium over government bonds in the next 80 years as they 
did in the last 80.    I think historic risk premiums, particularly those 
coming from the US, are too high.

>Look at it from an intuitive point of view - the risk premium
>for investing in shares should not be constant, it should depend on
>the state of the market.  As markets rise in value and become more
>fully valued, shouldn't the risk premium rise to compensate investors
>for an increase in risk from entering the market at that point?  

If you are arguing here for some sort of 'safety factor' to be introduced 
into investment decisions, to ensure that people invest less in markets 
when they are too high, then I think you have a valid point.

But is building this 'safety factor', which some might suggest builds in 
an expectation that markets *must return* 13% pa on equities in 
perpetuity for investing in the sharemarket to be worthwhile into the 
'risk premium' the way to do this?

>more importantly act as  a 'brake' to avoid overvaluing shares in that
>particular market.  My intuition tells me that that investing in the
>US market is in such a situation and to a lesser extent so are we
>here!   I'm finding it harder and harder to find real bargains in NZ.

So your inclination is to sell out, and what, put the money in the bank?

Are you suggesting here that the dividend from a share yielding 5% 
gross when deposited into your bank account is somehow 'worth less' 
than the interest from an equivalent amount of money invested in a 
bank term deposit at 5%?  I don't buy that argument.

Are you saying that the capital value of your shares are more likely to 
decline than the capital value of your term deposit?     I think that is 
true.      Couldn't you also argue that the capital value of your shares 
are more likely to increase than the capital value of your term deposit?

If your goal is to accumulate as much wealth as you can by retirement 
age, or alternatively accumulate a preset goal of wealth so that you 
can 'retire early', which is riskier?   Term deposits or shares?

>at the moment the risk premium I am using appeals to my intuition
>that the markets are starting to become more fully valued and thus
>more risky and so my valuations are more conservative to protect me
>from this.  On the other hand you are intimating that you are happy
>with the current risk of the market and don't perceive it to be as
>fully valued - and are thus placing a higher valuation on the stocks

I try to look at shares as businesses.   If the business case stacks up I 
will buy the shares.   I am not 'happy with the current risk of the 
market'.   In fact I don't care about it because I don't buy 'the market'.   
Frankly what Mr Market does is his own affair.    However, I am aware 
that Mr Market might have a meltdown and that the share price for 
businesses that I have bought into might decline to below what I paid 
for them- for a while.   I am also aware that when such declines 
happen they are often sudden, brutal and unpredictable (as to their 
timing and full extent).    However, I also know that good businesses 
will still arguably be good businesses despite what Mr Market says 
about them on any one day.   So I'm not worried if the market crashes.   
I am worried only if I have to sell when it crashes.    And I make darn 
sure I don't have to do that!


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on Pegasus Mail version 4.02
"You can tell me I'm wrong twice, 
but that still only makes me wrong once."

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