James Bowen takes a look ahead to the end of this year, and shares his thoughts on four likely scenarios that may come to pass.
Today we live in an environment of extreme uncertainty. More than 26 million Americans who had jobs a month ago are now unemployed. No one can tell you whether that number will be bigger or smaller a month from now. We have seen negative prices for the West Texas Intermediate oil contract, but that same barrel traded yesterday for $28.82 for December delivery, giving a tremendous premium to anyone who can store crude oil. As I previously posted, the expectations of risk priced into equity markets have unquestionably increased; it’s difficult even to estimate how much, because any estimate of future cash flows at this point is mostly guesswork. Point estimates are worthless and even probability distributions of future outcomes are likely based on shifting sands.
The four outcomes explored are:
- International Competition
- Prolonged Recession
- Robust Recovery
Read the full article, Four Scenarios for Year-End 2020, on LinkedIn.
James Bowen takes a moment to muse on risk expectations and market values.
Today I read Christopher Schelling’s insightful article in Institutional Investor, “The Dust Bowl Ravaged 1930s America: Coronavirus is Today’s Equivalent.” It led me to thinking about risk, and in particular how a risk no one considered at all a little over a month ago has emerged to destroy trillions of dollars of value — perhaps not in percentage terms, but certainly in dollar terms the largest destruction of value in my lifetime. How can this be?
The market value of anything, whether a farm or a necklace or a share of stock, is what someone else is willing to pay for it. In financial markets, we should see a relationship between the market price of an asset and its future cash flows, discounted for the riskiness of the asset. The riskier the asset, the greater the rate of discount of the future cash flows. Of course, it’s all more complicated than that, but at its very core the foundational principle of modern finance is that return is commensurate with risk, and the sum of the expected future returns on an asset tells us what it is worth. When the riskiness of future returns increases, present value decreases, and vice versa. It’s that simple.
Read the full article, On Risk in the Coronavirus Era, on LinkedIn.