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Home Kuo’s Smart Take Smart Thought Of The Week: What-If

Smart Thought Of The Week: What-If

We have come a long way since the days of slide rules, log tables and programmable calculators.

I remember showing my kids my slide rule, once. They were mortified that complex calculations could be performed on something so archaic. They were probably wondering what I was going to show them next. Perhaps a lump of flint and a piece of pyrite to start a fire for the evening meal.

These days, instead of those primitive contraptions, we have laptops and spreadsheets, which, in my view, are probably some of the most useful tools for private investors.

They allow us to perform “what-if” calculations that can check the opinions of commentators. In ye olden days, performing complex calculations could have taken precious hours. But now, those hours have melted into minutes, if not seconds.

I recently built a spreadsheet to crunch some numbers on the panic-induced views about how the rise in bond yields could cause a sell-off in equities. It is undeniable that interest rates can act like gravity on the stock market.

Zero gravity

But just how much “gravity” will be needed to bring down the market. This is where “what-if” calculations are much better than off-the-cuff “Here’s what I think”.

It is a fact that US bond yields have risen. Those 10-year Treasuries, which are a proxy for risk-free returns are now around 1.3%. They were half that just six months ago.

In other words, they have doubled. But does that necessarily mean that they are double the burden for stock-market investors? If not, then how high will they need to rise before bonds are a better investment than shares.

This is where “what-if” can play a massive role.

If we buy a portfolio of shares that yield 4%, and the payout could grow 10% a year, we would have collected around $60 in dividends after 10 years for every $100 invested.

By comparison, we could have earned $13 for the same amount invested in 10-year Treasuries at 1.3% over the decade.

Put another way, those Treasury yields would need to rise to 7% or a full 3% more than the current dividend yield before Treasuries will come anywhere close to making financial sense. And that doesn’t even include any capital growth.

As legendary investor Peter Lynch said: “Gentlemen who prefer bonds don’t know what they are missing”.

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Disclosure: David Kuo does not own shares in any of the companies mentioned.