Question 1: Can you explain in simple terms what effect the bond market has on shares? Are particular shares more affected by current bond movements, and should investors be concerned about current bond activity?
Answer: Fundamentally, bonds are an alternative asset class to shares. So if bond yields go higher and bond prices cheapen (bond prices move inversely to bond yields), then usually, share prices will fall to make them more attractive to buyers. This doesn’t necessarily happen immediately – but it will happen over time.
You can also think of it this way: a share price is essentially the present value of the future earnings of the company. These are discounted to bring them back into “today’s dollars”. The discount rate is usually the benchmark 10-year government bond yield. If the bond yield is higher (ie a higher discount rate), future earnings are worth less in “today’s dollars”. So, higher bond yields mean lower share valuations. This is one of the reasons that “tech stocks” and other high growth companies were impacted when bond yields started to rise – more of their share price is in “future earnings”.
Finally, stocks that are most impacted by higher bond yields are the so called “bond proxy stocks” – companies that have annuity-style income streams. Property trusts, utilities, toll road companies such as Transurban come to mind.
Question 2: Would you recommend reinvesting in Westpac (WBC) following the off-market share buyback?
Answer: Yes, for the medium term and to close the gap with Commonwealth Bank. Here is why, as covered in today’s Switzer Daily.
Question 3: Paradigm Biopharmaceuticals (PAR) has just received approval from the FDA (US Food & Drug Administration) to conduct Phase 3 trials. Can you clarify what this actually means, as well as the short and long term implications?
Answer: Paradigm (PAR) has received approval from the FDA to proceed with a phase 3 trial evaluating injectable pentosan polysulfate sodium for the treatment of pain associated with knee osteoarthritis.
A Phase 3 trial is the “big one”. A clinical trial with real patients, placebo, double blind, randomised and in multiple geographies. They are usually pretty expensive to run and can take considerable time, often years. But the pay-off is huge – if the trial is successful and the FDA approves the use of the drug, then it can be sold and distributed in the US. If the FDA approves it, approval in other countries is then relatively straightforward.
That’s why the share price has gone up on the news that the FDA has approved the trial – but it will amount to nothing if the trial is not successful.
An anxious, but potentially long (and profitable) wait.
Question 4: BHP is below $37.00, Rio less than $90.00 and Fortescue is near $14.00. Do you think they are a good buy at these prices or do you think they will fall further because of the iron ore price?
Answer: I am nibbling at these levels. I am cautious because, in the short term, it is all about the iron ore price. Some analysts say that it is in a “bear market” – but I have yet to meet an analyst who is consistently right in predicting the price direction. My sense is that with world economic growth on the up, there will be demand for the commodity in the medium term. The time to buy these stocks is when others want to sell.
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