The decision is between a higher probability shorter realization, bigger annualized result vs longer realization, lower annual return (possibly bigger return if things go particularly well) with a bigger probability of things going wrong, especially a few years into the future where the crystal balls get less sure of themselves.
I can get a real 30% return this year and I'm out with high probability. Vs I could get 150% in 7 years time but not much this year or next and maybe it won't work out because the unknown unknowns etc?
If you're pretty sure you're on a winner you take option b and hold. If you're less sure, a bird in the hand is worth two in your dreams... Your bonus this year is on this year's results, will you still work there and get the bonus in 7 years? The decision is probably not made by the owners of captial but their professional agents.
The interest rate really doesn't figure in that calculation (real returns rather than nominal). It's all about the return probabilities and good enough with more certainty can win out where you might not like that and think more highly of the longer term prospects.
Factoring in interest rates, when they're high its because inflation is high. At that point an inflation hedged investment (which most equity is) becomes relatively more valuable than money in the bank (bonds) because money in the bank is a sure, steady loser. Capital has to go somewhere and its owners will want to put it where it can "lose the least" Get it invested in some kind of business equity, diversified as hell, across industries, business sizes, geographically, startup vs established, precious metals, Art, all of it. Just get the hell away from bonds which will hemorrhage value from the inflation. Where capital is having trouble finding investment because all captial owners are looking the incentive becomes to hang on and hold, let the business run rather than rip the value out now and have to find somewhere else equivalent to put it which may not be easy at all.
Real interest rates are the growth rate in the overall economy, which doesn't change much or at least shouldn't in the absence of a crash and recession. For a country getting much above the world economy growth rate is a short term thing that doesn't last. You hit oil (norway) Your capital stock was low (post ww2 germany & japan, pre economic liberalization of china) but you have an educated and entrepreneurial population and you can catch up fast by investing, then reinvesting in capital. Then it tails off when you get back to parity).
The world economy growth rate is set by population growth and technical progress. (Both new technology and new ways developed to use existing tech better).
>Bond interest rates already price in expected inflation.
Look at the incredible growth in the S&P500 during a pandemic with all the economic carnage going on with that vs the bond rates. Then if you still think so, bet so, but against my strongest feelings, which are obviously not any kind of investment advice. There are cashflow timing tax effects to consider there as well. Bond returns are depressed by central bank policy and some capital is forced to allocate there when its a bad deal. (Pension funds mandated to invest in bonds and nothing "risky" like equity). Look at the number of ways an investment in bonds can surprise on the downside. Look at the lack of room with interest rates where they are to surprise on the upside. Unanticipated inflation is a redistribution from lenders to borrowers (can pay it back with worthless currency while the asset it bought appreciates). It's always "unanticipated" in most of the yield curve when it hits.
20 Year US Govt Bond yield is 2.07% sayeth the search engine [1]. That's anticipating basically no inflation at any point for the next 20 years and a 2%ish economic growth rate in the economy. Seem like a reasonable assumption? Bond income (coupon payment) is taxable as you get it. Capital appreciation of equity isn't taxable until you sell it. In times of inflation that really matters and causes you to make a small fortune out of a bigger one.
No, real interest rates are not (necessarily) the growth of the entire economy. Interest rates are the cost of borrowing capital.
Eg if we discovered that an asteroid was going to hit earth in ten years, you can bet that interest rates would go up like crazy---without any growth nor growth expectations.
Of course, real interest rates can be related to real growth in the economy.
> Look at the incredible growth in the S&P500 during a pandemic with all the economic carnage going on with that vs the bond rates.
I'm not sure what you mean here? Econ 101 says that the price of stocks is the discounted present value of all expected future dividends (and stock buybacks etc). If you follow that simple model, it would already predict that a short term disruption to the economy should not impact stock prices.
Of course, reality is more complicated. But even this simple model captures the phenomenon of robust stock prices while a pandemic is still going on.
> Bond returns are depressed by central bank policy and some capital is forced to allocate there when its a bad deal. (Pension funds mandated to invest in bonds and nothing "risky" like equity).
Yes, regulation makes things more complicated here. Also keep in mind that in most jurisdictions companies pay bond or loan interest with pre-tax money, but they pay dividends or stock buybacks with post-tax money.
The wider context of the discussion was about junk bonds from private equity. They benefit from the difference in tax treatment, but don't benefit from pensions funds' mandates to invest in safe assets or central bank purchases of government debt.
I'm not sure why you would cite 20 Year US Govt Bond yields here? If you are interested in inflation expectation in the US, just look at TIPS spreads https://fred.stlouisfed.org/series/T10YIE which give you that information directly.
TIPS spreads are the difference in price between inflation adjusted bonds and non-inflation adjusted US government bonds.
> It's always "unanticipated" in most of the yield curve when it hits.
Eh, there's also unanticipated lack of inflation. The risk goes towards both sides. (A risk that only goes in one direction would be rather strange, if you have at least a few smart market participants who can benefit from correction prices.)
The decision is between a higher probability shorter realization, bigger annualized result vs longer realization, lower annual return (possibly bigger return if things go particularly well) with a bigger probability of things going wrong, especially a few years into the future where the crystal balls get less sure of themselves.
I can get a real 30% return this year and I'm out with high probability. Vs I could get 150% in 7 years time but not much this year or next and maybe it won't work out because the unknown unknowns etc?
If you're pretty sure you're on a winner you take option b and hold. If you're less sure, a bird in the hand is worth two in your dreams... Your bonus this year is on this year's results, will you still work there and get the bonus in 7 years? The decision is probably not made by the owners of captial but their professional agents.
The interest rate really doesn't figure in that calculation (real returns rather than nominal). It's all about the return probabilities and good enough with more certainty can win out where you might not like that and think more highly of the longer term prospects.
Factoring in interest rates, when they're high its because inflation is high. At that point an inflation hedged investment (which most equity is) becomes relatively more valuable than money in the bank (bonds) because money in the bank is a sure, steady loser. Capital has to go somewhere and its owners will want to put it where it can "lose the least" Get it invested in some kind of business equity, diversified as hell, across industries, business sizes, geographically, startup vs established, precious metals, Art, all of it. Just get the hell away from bonds which will hemorrhage value from the inflation. Where capital is having trouble finding investment because all captial owners are looking the incentive becomes to hang on and hold, let the business run rather than rip the value out now and have to find somewhere else equivalent to put it which may not be easy at all.