Cheat sheet for how to show off this weekend

Today I’m going to give you some ammo to dazzle, alarm, impress and/or annoy your friends this weekend.

Buoyant figures out yesterday confirmed things are still steaming ahead in the States. The US economy grew faster than anyone expected in the three months from July to September – by 4.9%. This is its fastest growth rate in 2 years. Despite relatively high interest rates of 5.5% in the US (compared to 3.25% a year ago), consumers are still spending.

You might be tempted to think that shares would soar against a backdrop of nice growth, but not so fast. Quite often the stock market seems almost blind to what’s going on in the High Street and the broader economy. And this week, the stock market in fact slumped on the back of disappointing results. On Wednesday, tech firms had their worst collective day in 8 months.

Why? People are worried their valuations are too high at a time of high Treasury yields. Huh?

Treasury yields are basically the interest the US Government will give us if we lend them some money, or the money we make on this loan. These ‘yields’ are currently around 5% in the US for a 10-year loan.

Of course, investors have a choice of what to do with our money. We can lend to it a rock-solid Government and get a pretty secure 5% rate of return. Or we can invest it in shares. Trouble is, a company like Google’s parent Alphabet is priced so high that there is absolutely no margin for error. When they report a B+ set of results instead of an A, some investors think, “Stuff this. You’re not giving me enough bang for my buck, I’m better off doing something more boring that gives me 5%.”

This concept is what City folk called the “equity risk premium”.

Think back to when interest rates were pretty much 0%. And then imagine you can invest in a collection of shares with average expected returns of about 7% a year. Many would take the risk, for the chance of a return which was 7% higher than cash. You take the risk of being in equities (or shares). For a premium.

Fast forward to today with interest rates of 5.25% and that same collection of shares looks a lot less appealing – with the chance of making only a smidge more than cash. The equity risk premium isn’t high enough to make it worth it.

And this is at the heart of why money market funds are amongst the bestsellers on platforms. And why start-ups are struggling to find investment. And why we don’t hang around when company results are a bit ‘mweh’.

So there you have it. Down the pub this weekend, you can trot out, “Of course equity risk premia are at multi-year lows, which leaves little buffer for earnings disappointments”, toss your hair back and stride to the bar.

At a time of jittery nerves about high share prices, the UK is one market where valuations are not so stratospheric. This week’s sponsor BlackRock remind us that a broad UK basket of shares - the so-called ‘MSCI United Kingdom’ - is trading at a price to earnings ratio of 11.8x, compared to 20.3x for the MSCI World. In other words, their valuations seem more reasonable. Food for thought. You can read more about the UK in this article, or if you’re just interested in generally learning more and building your confidence, this page outlines 10 key things for all beginners to know about investing.

Have a great weekend everyone.

Holly

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