IS IT TIME TO GET OUT OF BONDS?
Shore Capital says it’s time to get aggressive on equities as the bond bullishness has reached a plateau (via Bloomberg):
Investors should favor stocks over bonds, according to a gauge based on the relative value of the two asset classes which correctly signaled the rally in equities that began in March last year.
The monthly gap between the earnings yield of S&P 500 and the 10-year Treasury yield, adjusted for historical volatility, as calculated by Shore Capital. July’s reading was minus 0.32, down from as much as 1.26 in May. A negative reading is bullish for stocks, while a positive one suggests bonds are more attractive.
“Equities are no longer overvalued, as they were at the start of the year,” Gerard Lane, a London-based strategist at Shore Capital, said in an interview. “Given the rapid decline in government bond yields, based on trend earnings this signal is suggesting a switch from bonds to equities.”
(Chart courtesy of Surly Trader)
This is not merely a story of oversold or overbought, however. Surly Trader discusses the pertinent theme here:
“At the heart of whether equities look more attractive than bonds is the question of whether inflation or deflation will emerge within the next few years. If we believe in the Japanese outcome, then the wise have prevailed and corporate bonds will save the day. On the other hand, if inflation is sparked by renewed growth and the Fed’s fuel on the sparks, then an investment in 10 year treasuries at 2.6% will be an embarrassing trade. My vote is on the latter.”
Betting on another lost decade? I don’t think that’s so wise. Even the worst of my projections say the debt de-leveraging (and deflationary cycle) ends well before 2020. Even as a deflationist who has called this macro environment more accurately than most I have to admit that buying a 10 year at 2.5% and holding to maturity looks like a terrible bet. On the other hand that doesn’t mean government bonds won’t continue to be a good bet in the coming years as we remain mired in a balance sheet recession that elevates market/economic risks and keeps a lid on near-term inflation risks.
I assume you saw Jeremy Siegel’s piece in the Journal today. I find all the screeching on behalf of equities a slightly contrarian indicator. The reasoning seems to be that as bond prices rise, equities must be cheap (in comparison). Problem with that is that bond prices are rising FOR A REASON. This isn’t a mindless bubble a la housing or tech. It’s investors making an economic call – and though retail investors are late to the game, the smart ones have been there for a while. To conflate the run-up in bond prices with just another bubble is to miss the point entirely. Either that, or your talking your book (literally in Siegel’s case of course).
This is, in large part, why bond traders are thought to be smarter than equity traders. The common equity trader spends time studying moving averages, volume and less time studying the actual fundamentals (I am generalizing of course). But because bonds tend to be longer in duration and tied more directly to visible macro trends the traders who trade these instruments tend to be much more precise in their research. At least in my opinion.
If I could hire a few people to start a hedge fund with my first two picks would almost certainly be Bill Gross and Jeff Gundlach.
Sorry, but when most of the recent buying that plunged yields below 3% has been by the Feds, the move is hardly a reliable gauge since it is a re-allocation of mortgage holdings.
Actually, I notice just as much, if not more, talk of Ten year yield going much lower, to test 2%. The few who call for buying equities invariably get pummeled by the horde of bearish media and bloggers. Today’s investor intelligence supports the idea that bulls have gone back into hiding and bears are getting far too confident in Armageddon scenarios. In other words, I agree with the author, equities are a buy.
There is a huge wave of boomers approaching retirement who, according to David Rosenberg, are overweight equities and underweight fixed income. The trend towards greater fixed income allocation will only intensify in the coming years. Try convincing a 55-year he needs to allocate more of his retirement funds towards equities, especially after living through two 50%+ crashes in the last ten years.
This whole conversation is stupid. There is a fixed amount of bonds in the world and a fixed amount of stocks in the world (barring small amounts of new issuance). People don’t shift out of one asset and into another. There is no cash on the sidelines or money causing tidal waves. When prices change they change because of sentiment. If you want to buy bonds more than the seller needs to sell them then you’ll buy high(er). It’s that simple. There is no massive reallocation going on.
In other words it all comes down to fundamentals in the long-run. Anyone pointing to fund flows or anything else is just plain stupid. Stocks look like crap in the long-run because historically expensive and future growth looks terrible. That’s the main reason why people are piling into corporate and govies.
Looking at the macro environment, how can anyone want to buy stocks? I have to hold my nose to do it and I’m hedged up to my eyeballs on what I do have long.
Your Bill Gross draft pick is interesting.
My #1 pick would be Hugh Hendry.
I do find it thoroughly interesting to see so many people attempting to use the same tools that guided them over the past twenty years in their efforts to understand what we’re dealing with today.
Most of them appear to be career men; stewards of the big bulwark long only shops that have put up great numbers chasing beta in a continuous bull stampede (ex them getting crushed in 00-02 and 07-09).
When you have $30+ B in AUM you are a slave to the bull.
The yield curve inversion thing is one of my favorites that’s still bandied around on TV today.
TPC,
You see the piece on Ritholz’s site about bonds being similar to the dot coms?
http://www.ritholtz.com/blog/2010/08/do-us-bonds-resemble-dot-com-stocks/
I generally love Barry’s work, but this is so far off the point. The misinformation in markets is simply unbelievable when it comes to how the debt markets actually function. This all feeds into the deflation debate and how a govt actually issues debt so it’s right up my alley….
How can a security that guarantees an interest rate and matures at par ever be in a “bubble”? People just throw these terms around like they’re meaningful. Bubble this and bubble that. How long have we been hearing about this bond market bubble? 5-10 years? Are bonds at risk of a 90% loss like the dot coms? Absolutely not. ABSOLUTELY NOT. Not unless you’re in the hyperinflation camp….in which case I’ll just say good luck betting on the demise of the reserve currency. You’re better off betting on a meteor striking your neighborhood. Could inflation jump to 4-5%? Sure. In which case you’d be out a few % points in real terms per year. The comparisons to a bubble are very misleading. I wonder if people would be making such comments if interest rates were at 6% and inflation was at 4.5% (which is the exact environment – 1.5% real yields – we are in now)? Do you see the absurdity in that?
It’s a disaster to hold ten years at 2.6% if inflation shoots up. Barry is looking at risk reward and buying the ten year here is dangerous. It’s much safer to buy JNJ yielding 3.7% and a solid recession proof outfit. If there is the slighted hint of inflation, you will be stuck with that bond because getting out will be very, very painful, even on a move to a reasonable 3.25% for ten year yield. Barry is right.
I don’t deny that the long bond at 2.5% is not a screaming deal. But to compare it to the dot com bubble in which you lost 90% from peak to trough is an outrageous reach. If you hold it to maturity you might lose a few percentage points per year in real terms. That’s not a total disaster as the dot com bubble was for many investors. Scared out of your mind by this “bubble”? Buy some TIPS and get on with your life….
All I’m saying is that the comparison is silly and very very misleading because it implies that you might lose your nest egg in govt bonds.
Got it. In any case, the old Vanguard rule should apply: buy your age in bonds (50 yeas old, 50% of your portfolio).
Vanguard, what a great company. Speaking of them, check this out. It’s a great read and targets on our conversation. http://www.vanguard.com/pdf/icrrol.pdf
“When evaluating the potential risks in the bond
market, it is critical to remember exactly why bonds
are an integral part of a well-thought-out asset
allocation plan—to diversify the risk inherent in the
equity markets. Simply put, while the fear of rising
interest rates may be legitimate, a potential bear
market in bonds is dramatically different from a bear
market in stocks (or other risky assets). In fact, unlike
stocks, where the common definition of a bear
market is a 20% decline in prices, to most investors
a bear market in bonds is simply a period of negative
returns. And to date, the broad U.S. bond market has
never experienced a –20% return. Indeed, it’s the
magnitude of returns that is the key differentiator
between bad periods for bonds versus stocks. For
example, the worst 12-month return for U.S. bonds
since 1926 was –9.2%, while the worst 12-month
return for U.S. stocks was –67.6% (12 months ended
June 1932).
3
In another example, the worst calendar
year for the broad bond market was 1994, when due
to an unexpected upward shift in interest rates, the
bond market returned –2.9% (in 1995, the bond
market returned 18.5%). Contrast this to the
experience of stock investors in 2008, when the
Standard & Poor’s 500 Index lost more than –2.9%
in 27 individual trading days.”
Hope that clarifies my thinking a bit….
Excellent.
Barry’s a standard equity guy. He kind of pretends to understand global macro, but I don’t think he really does. He really shouldn’t bother commenting on things like this. It just makes him look foolish.
He gets it better than most and at worst he appears open minded enough to at least listen to alternative thinking.
RMBS- guaranteed interest, matures at par. That is, until they didn’t. Bubble. Not an immediate subscriber to the UST bubble call. But there will come a time, probably around 1.75%.
I think I get the gist of actual investment in bonds vs stocks but for the average investor out there, when we invest in bonds, most of us invest in bond funds such as total return from PIMCO which could lose value in a rising equity environment. Does anyone know that actual percentage of investors who buys pure bonds instead of bond funds?
Thanks,
Mike
This “analysis” is based on the so called Fed Model, which is a worthless pile of junk and completely misleading.
John Hussman debunked this one long ago:
http://www.hussmanfunds.com/wmc/wmc070820.htm
German 10 years are yielding less than US 10 years, and Germany had a China-like GDP expansion in the 2nd quarter. There’s something else going on here.
Can bond prices fall? Of course. Are they a bubble? Of course not.
How come you stopped making market calls like the old days? You stopped doing that investment outlook thing as well.
It’s been a busy summer. Sorry. I’m behind on a lot of stuff.
I suppose you care because you’re just looking to troll, right? Your comment history is a horrid pile of feces. Honestly, you should be embarrassed as an adult, that you spend so much time trying to insult and denigrate total strangers. Yet you come here every day and read every article and then spit on me when it pleases you. It’s disgusting.
Wait, you’d give money to Jeff Gundlach (who I like) but you said in other posts he does not even understand money. That is irony – in your mind your top pick would be someone who does not understand economics 101 (according to you).
As for PIMCO’s Bill Gross, you basically have a guy who is “inside” the game. His firm is now so big it can dictate to US Treasury what it wants, and has been doing so the past 3 years. He is trying to do it right now with GSE reform. He says he won’t buy unless he has govt backstop. That’s a good capitalist? No, but maybe a pragmatic one. If you call that capitalism. He is a crony…. a very smart crony but a crony.
I said Gundlach believes there is solvency risk in the USA (which I disagree with and is entirely up for debate). I actually said he was a brilliant bond manager and aside from this one thing I believe he understands the environment better than just about anyone.