Equities: What Fundamental Value In Your Portfolio? Developing ...

I was reading Felix Salmon at http://www.portfolio.com/views/blogs/market-movers/2009/01/08/buying-equities-for-their-option-value?tid=true today. So, decided to list some of my thoughts, but developing...

The most important at Felix was, in my view:

The important thing to remember is that if you have a fixed-income asset, broadly defined -- it might be credit, or Treasuries, or even cash -- your downside is nearly always much bigger than your upside. No matter how safe you think you are, you can always be wiped out in some freak financial tsunami. Stocks can go to zero too, of course, but they have unlimited upside, and a small probability of a huge gain is something worth paying good money for.

I have to add to Felix, that any (debenture?) instrument - not only fixed-income, but also floating rate notes (and include here also all structured stuff too by reducing the option value!) ... Well, and then - NOT your downside is nearly always much bigger than your upside, but your upside is always limited, but no downside limit... (still the same asymmetric risk)!

At the moment, still the equities may appear cheap in the context of last 30 years, but they have been cheaper in the context of last 100 years. I do not know, will they be (or not) more cheaper, but current earnings estimates may be high. The global macro-economic environment and the pre-announcements this week - alike Alcoa, Intel, Wal-Mart, Chevron etc., suggest that consensus earnings estimates, indeed, may be too high. At current estimates they are trading more than 20x PE, well above historic average. Well, with promised ZIRP (zero-interest-rate-policy) by Fed in mind, some may think it is cheap, but realized volatility of everything at the moment suggest high risk premiums for high uncertainty. And who is going to pay for fiscal stimulus ... at the end?

I would say - equities are derivatives, that are function of macro-environment "de-graded" by credit factor and a long-term bond duration, but multiplied by "operational excellence". It is developing ...

Equities = Macro - Long-term Credit Factor and Duration*/ "Operational Excellence" ??

Well, if we assume that there is a probability of equities going below their 2002-2003 lows, and if they do - then the value of equities will be re-assessed fundamentally (e.g., look at Japanese equities for the last 30 years)...

It may be destructive for "animal spirits", but a price of "fiscal stimulus"?

Did I get it on the right way? Think about that ... Developing.