What the Bond Rally Means for Stocks
Comparing bonds and stocks is crucial for investors. Here is a good current lesson
Bespoke Investment Group does a great job of analyzing trends and historical results. Co-Founder Paul Hickey was featured today on CNBC. As usual, he had some great observations. Without disparaging the other guests, I would like to focus on the hard data he presented.
Paul noted that bonds had rallied 10% in four months. This has happened 14 times in the past and the S&P 500 has been up about 15% on thirteen out of fourteen times. If you add in the combined effect of the stock decline and the bond rally, there are only four occasions and the rally (in all cases) becomes 25%.
Here is the entire interview. Paul's key comments start at about the 3:30 mark.
Paul's key point is one that a few others are noting — the relative valuation of stocks and bonds.
Stocks versus Bonds
Many large players constantly review asset allocation among major investment categories. The forward earnings yield of stocks (perhaps adjusted for some skepticism) is constantly compared to bond yields. I am always surprised when I learn that someone who is basically an equity investor is unaware of the potential yield from alternatives.
One problem is that the projected yields do not reflect overall interest rate changes. It is fine to expect 4.5% or so from long-term corporate bonds, but you will have capital losses if interest rates increase. My analysis suggests that the forward earnings yield of the market has roughly paralleled the rates of lower-grade bonds. You can "reach for yield" and find something that generates 8.5%. That looks good on a day when the market is down two percent.
For most investors, it is better to take a longer view. I find most individual stocks to be more attractive than the corresponding bonds, and the overall stock market more attractive than the overall bond market. This does not mean that you have to be "all in" like the players in the World Series of Poker. Most investors are making the opposite mistake. They are opting for minuscule yields without any attention to long-term growth and inflation.
Meanwhile, most investors are doing the opposite. They see yield as some sort of guarantee while worrying about the risk in stocks.
I wish that more people could have heard the highlighted CNBC segment. It seems like the dramatic predictions — Dow 5000, Dow 1000, the "New Normal — get all of the attention. Not a week goes by without a message from someone who is worried about a market collapse. It is an imbalance of writing, media coverage, and commentary. Most people would do well to consider the likelihood of Dow 20K. A recent CNBC poll found a third of their audience predicting that the market would NEVER reach Dow 12,000. A generation of investors is missing on a chance to own a share of America. It has become fashionable to be negative.
By contrast, take a look at an excellent article by James Altucher. He analyzes trends in earnings, employment, China, and the GDP. Careful readers will note that he accurately cites data. He also has a number of stock suggestions which are now on my watch list for analysis. Meanwhile, the comments section is typical of current feedback for those of us writing on the Internet. The reader feedback can be directly discouraging to authors, but it also influences editors and those hiring writers. The comments of a small minority may affect what regular readers get to see.
Comments could be the ultimate sentiment indicator if someone could figure out a good measure.