Tuesday, 3 March 2009

A sustainable bottom

I have always been fascinated by the subject of bottoms, especially, but not exclusively, to those that arise in capital markets. Here is my very simple formula for deciding when a sustainable bottom might be in place in equity markets once we move beyond the prevailing sour mood that is deflating the animal spirits.
Assuming that we are still in a relatively benign interest rate environment in the coming years - which actually is itself a rather suspect assumption, but anyway - there could be reason to suppose that equities will stop their decline when, in the major economies, esp. the US and UK, the median price of a family home is more or less equal to four times the median family income.
That way asset valuations can be built on sustainable multiples that only rely upon relatively predictable income flows and mortgage outgoings rather than upon factoring in speculations about future capital appreciation of property values. That's where it always goes wrong.

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