Analytics
Analytics are at the core of how BML funds operate. We want to share some of our stock market analytics to demonstrate how we operate and stimulate discussions on how financial markets are priced. We welcome engagement on any of the charts presented below, please feel free to reach out on info@bmlfunds.com
None of the data below can be considered a forecast or financial guidance and all advice is general only. All calculations have been done by BML Funds and any errors are our own. In particular, please note that there are many methodologies for calculating equity yields, equity premiums, risk, correlation, and depending on the particular purpose and use of a chart the outcome of two charts shown here may be different. Is the expected equity yield 6.5% or 7.4%? There's quite a variation, but one method has to be consistent through history with the variables available (we run this model back to 1988), while the other is a point forecast today based on all the variables we can observe. The discount rate / equity yield / expected return is not a known observable variable, as it's the future return implied by market pricing and variable inputs. It's the relationship shown within a chart that is the most important.
The equity premium
Weekly data Jan 2007 - 16 August 2024.
The equity story has been uneventful: Priced around a pretty normal 7% for some time. The action has been in bonds, with 10 year yields rising above 4%, before recently falling back to 3.9%. The equity premium seemed too low, but with positive correlation between bonds and stocks this was no surprise.
This is a first order chart - we haven't considered risk
Equity premium with risk
Monthly data Feb 2006 - July 2024
This uses a different methodology than the chart above, and considers the equity return premium against the equity risk premium (equity volatility minus bond volatility).
We see something unusual - equity risk premium is at 15 year lows, which explains the low equity return premium.
On this basis bonds aren't cheap against stocks, given the relative risk it looks pretty normal against history
Stock risk vs return
Weekly data 3 June 2005 - 16 August 2024
This chart shows expected stock market risk and return weekly over 19 years. Pre-covid data showed somewhat consistent investor trade-off between risk and return.
During covid risk was higher than normal and expected returns fell. Investor risk appetite rose and their discount rate fell, by this data.
We have shifted back towards more normal market conditions now, and risk has fallen significantly.
Capital Markets Line
Blue data is average Jan 2000-Jan 2020, Orange is July 2024
The capital market line, or CML compares risk to return for asset classes. Here we show stocks, bonds, and inflation.
The orange line is current and shows a pretty normal relationship.
The blue line is the average over 20 years - beware averaging and period bias, but the historic risk-return trade-off was somewhat superior to the current, due to better risk and return from stocks on average.
Real stocks vs bonds CML
Monthly data Feb 2006 - July 2024
Adjusting the yields for inflation, stock returns and risk look normal and bond yields offer an inferior relative return, but this is consistent with bond history by this measure.
Equity yields didn't change much with inflation, which reduces real returns
Bond-equity correlation
Weekly data updated 01 Jan 1988 - 16 August 2024
Undoubtedly the most interesting chart in finance! Perhaps not, but here we show the changing correlation paradigm. Pre 1998 stocks and bonds were positively correlated: bond yields rising was associated with the price of stocks (and bonds) falling. Then from 2000 to 2020 the relationship reversed, and bond yields rising was associated with stocks rising. We forecast that the relationship would flip back and it has. Perhaps that has ended recently!
It's all about real vs nominal shocks.
Securities Market Line
Blue data is average Jan 2000-Jan 2020, Orange is July 2024
The Securities Market Line (SML) is a core concept in portfolio theory, but it's not one you see replicated in practice. We have done so here. The SML shows the relationship between correlated risk (beta) and the return on asset classes.
The current SML in orange is below history in blue.
One wonderful concept here is to consider the dynamics of the bond - equity relationship and how correlation interacts with the yield premium. Consider when bond yields were crazy low, what was the correlation? Very negative. Most portfolio managers use a CAPM framework for their DCF discount rates - but struggled to force very low bond yields into their framework. This would have helped.
This document has been prepared and issued by BML Funds Management Pty Limited (Investment Manager) (ACN 664 470 991) BML Funds Management Pty Ltd is a Corporate Authorized Representative (No. 001230) of Havana Financial Services Pty Ltd (ABN 90 619 804 518, AFS Licence No. 500435) (Havana). Any advice contained in this communication is general advice only. None of the information provided is, or should be considered, personal financial advice. The content has been prepared without taking into account your personal objectives, financial situations or needs. If you consider it necessary you should seek your own advice before making any financial or investment decisions. The information provided in this communication is believed to be accurate at the time of writing. None of BML Funds Management, Havana or their related entities nor their respective officers and agents accept responsibility for any inaccuracy in, or any actions taken in reliance upon, that information.
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