It"s Not Too Late To Invest In Stocks
Everyone is taking notice of the stock market as its hits new highs and they want to know if this is a good time to come back in.
They worry that the market is now too high and are afraid that another 2008 is right around the corner.
Well, no one can know precisely, but I think the chances of a big decline slight right now.
We are not in for a big shock to the economy or the stock market, and there is good reason to think that today's prices are exactly where they should be.
Allow me to explain First, it's all about interest rates.
There is a direct relationship between interest rates and asset values, but many aren't educated on how one affects the other.
Perhaps using a purchase of a new home would help to illustrate.
Let's suppose you wish to buy a home for $500,000 and you decide you will get a mortgage for 100% of the value.
(Of course, this is not possible, but it simplifies this illustration).
Also, let's suppose the interest rate on the mortgage is 6%.
Using just the interest cost (to keep it simple), your annual cost to finance this home would be $30,000 per year or $2,500 per month.
Let's say that a mortgage of $2,500 per month is within your means and very affordable for you and it is this monthly cost which is enabling you to take on a mortgage of $500,000 at a 6% rate.
Now, let's see what happens if mortgage rates decline to 3%.
Using the affordability of $2,500 per month or $30,000 per year, you could now buy a house worth $1,000,000! That's right; an annual outlay of $30,000 would enable you to spend $1,000,000 for a home.
The simple math: $1,000,000 at 3% equals $30,000.
You will notice then, that a reduction in rates led to a rise in asset prices.
This is no different than one company looking to buy another company using its cash flow to borrow the money to pay for it.
Main point: It is the price at which real transactions are done that is always affected by the cost of money.
It is these real transactions-transactions that are grounded in good business practice which you can use to evaluate the worth a business.
In today's world, the yield on the 10 year US Treasury bond is just under 2% and very high quality corporations can borrow money at rates only slightly higher.
Therefore, if a company can borrow money at just over 2%, it can pay a lot more to buy a competitor than if its cost of money was 5%.
Since this would be a real transaction in a real business arrangement, buyers would find that stock prices are rising, just like home prices I mentioned previously.
Here's a real world example.
Apple just announced it was buying back $60 billion of its OWN stock.
Is it doing this with the cash it has in the bank? No.
It is borrowing the money to do so.
This allows Apple to buy its own stock and leave its cash alone.
The cost of borrowing the money is a lot less than the cost of Apple bringing its cash back to America with the result of paying a large amount of taxes.
Warren Buffet and another partner just paid a healthy premium to buy Heinz.
It could do this because Buffett's borrowing cost is so small that it enables him to spend more with the same amount of cash outlay.
We are beginning to see a lot of takeovers of companies at these higher stock prices because it's a real fact that low interest rates allow companies to pay more.
Do you see the connection now? You might ask me: "Steve, we have had low interest rates for a while, so why are prices rising to this level now?" It is my opinion that much of the money that was available for investment has been in hiding-scared to take risk and staying underground in bonds and money markets.
However since the economy seems to be on the mend, money is starting to come out of hiding and making its way into stocks.
Stocks seems to be one of the only places remaining to earn a decent return.
It is also my opinion that prices will continue higher for a while.
What could stop it? An uptrend in interest rates would have an effect, but it will be the pace at which interest rates rise which will determine the degree of damage.
If the rise is gradual and due to an improving economy, I probably won't be that bad.
If rates rise suddenly, it could cause a shock to the market.
What to do: Stay invested here and don't mind the day to day swings.
Invest in quality and by all means, before you invest, understand what you own.
This way you will have the right perspective if things start a serious turn down.
If you're not up to snuff on these complexities, find a good advisor and make sure he or she has a strong philosophy and enough experience to execute it successfully.
They worry that the market is now too high and are afraid that another 2008 is right around the corner.
Well, no one can know precisely, but I think the chances of a big decline slight right now.
We are not in for a big shock to the economy or the stock market, and there is good reason to think that today's prices are exactly where they should be.
Allow me to explain First, it's all about interest rates.
There is a direct relationship between interest rates and asset values, but many aren't educated on how one affects the other.
Perhaps using a purchase of a new home would help to illustrate.
Let's suppose you wish to buy a home for $500,000 and you decide you will get a mortgage for 100% of the value.
(Of course, this is not possible, but it simplifies this illustration).
Also, let's suppose the interest rate on the mortgage is 6%.
Using just the interest cost (to keep it simple), your annual cost to finance this home would be $30,000 per year or $2,500 per month.
Let's say that a mortgage of $2,500 per month is within your means and very affordable for you and it is this monthly cost which is enabling you to take on a mortgage of $500,000 at a 6% rate.
Now, let's see what happens if mortgage rates decline to 3%.
Using the affordability of $2,500 per month or $30,000 per year, you could now buy a house worth $1,000,000! That's right; an annual outlay of $30,000 would enable you to spend $1,000,000 for a home.
The simple math: $1,000,000 at 3% equals $30,000.
You will notice then, that a reduction in rates led to a rise in asset prices.
This is no different than one company looking to buy another company using its cash flow to borrow the money to pay for it.
Main point: It is the price at which real transactions are done that is always affected by the cost of money.
It is these real transactions-transactions that are grounded in good business practice which you can use to evaluate the worth a business.
In today's world, the yield on the 10 year US Treasury bond is just under 2% and very high quality corporations can borrow money at rates only slightly higher.
Therefore, if a company can borrow money at just over 2%, it can pay a lot more to buy a competitor than if its cost of money was 5%.
Since this would be a real transaction in a real business arrangement, buyers would find that stock prices are rising, just like home prices I mentioned previously.
Here's a real world example.
Apple just announced it was buying back $60 billion of its OWN stock.
Is it doing this with the cash it has in the bank? No.
It is borrowing the money to do so.
This allows Apple to buy its own stock and leave its cash alone.
The cost of borrowing the money is a lot less than the cost of Apple bringing its cash back to America with the result of paying a large amount of taxes.
Warren Buffet and another partner just paid a healthy premium to buy Heinz.
It could do this because Buffett's borrowing cost is so small that it enables him to spend more with the same amount of cash outlay.
We are beginning to see a lot of takeovers of companies at these higher stock prices because it's a real fact that low interest rates allow companies to pay more.
Do you see the connection now? You might ask me: "Steve, we have had low interest rates for a while, so why are prices rising to this level now?" It is my opinion that much of the money that was available for investment has been in hiding-scared to take risk and staying underground in bonds and money markets.
However since the economy seems to be on the mend, money is starting to come out of hiding and making its way into stocks.
Stocks seems to be one of the only places remaining to earn a decent return.
It is also my opinion that prices will continue higher for a while.
What could stop it? An uptrend in interest rates would have an effect, but it will be the pace at which interest rates rise which will determine the degree of damage.
If the rise is gradual and due to an improving economy, I probably won't be that bad.
If rates rise suddenly, it could cause a shock to the market.
What to do: Stay invested here and don't mind the day to day swings.
Invest in quality and by all means, before you invest, understand what you own.
This way you will have the right perspective if things start a serious turn down.
If you're not up to snuff on these complexities, find a good advisor and make sure he or she has a strong philosophy and enough experience to execute it successfully.
Source...