Smart Take Of The Week: Melt-Up

Whether we like it or not, we are living in interesting times. Very interesting times. But then, we have always lived in interesting times, and always will….

…. Black Monday in 1987 was an interesting time. The Asian Financial Crisis of 1997 was a very interesting time.

The bursting of the dot.com bubble was another interesting time. And how can we forget the Great Financial Crisis of 2008. That was an unbelievably interesting time.

Fortune favours the brave

By the way, “May you live in interesting times” is not a Chinese proverb, even though some people might think it is. The closest it has ever come to China is probably a scribbling that someone found in a fortune cookie….

…. If so, then the terrible jokes that we find in Christmas crackers should be included in some of the UK political parties’ manifestos for the country’s upcoming general election. They can’t be any less groan-worthy.

I will reveal my worst Christmas-cracker joke at the end of this article. But for now, let me tell you why I think we are living in interesting times….

Reference point

…. if you haven’t already noticed, interest rates have been falling faster than Donald Trump’s approval ratings. Some central banks have even cut interest rates to below zero.

But here’s the thing: interest rates can be an important reference point for investors. Buy-to-let landlords like to compare rental yields with bank interest rates. Stock-market investor will often compare dividend yields and earnings yields with bond yields.

So, let’s consider dividend yields, which is the ratio of dividends to share prices. What does a share price need to be for a given dividend payment for the yield to be zero? The answer is infinity….

Interesting times

…. now wash, rinse and repeat for the earnings yield. The answer is also infinity.

In other words, share prices could go to infinity and beyond if interest rates stay at these absurdly low levels. Or put another way, a stock market melt-up is not out of the question.

But we need to be careful.

Bond yields are now about as useful as a broken compass for a reference point on valuations. Consequently, we could, instead, look at historic price-to-earnings ratios, price-to-cash flow or price-to-book ratios to provide a sensible estimate for value.

Warren Buffett once said that a man who tries to carry a cat home by its tail will learn a lesson that can be learned no other way. We don’t want to be that man. So, don’t follow the crowd. Don’t buy overpriced stocks.

And now for my favourite Christmas cracker joke of all time: Who hides in a bakery at Christmas?

And the answer is: a mince spy. Ta-dah! Until next time….

None of the information in this article can be constituted as financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. Disclosure: David Kuo does not own shares in any of the companies mentioned.