Thursday, September 1, 2016

Many stock investors do not believe in Treasuries

Many stock bulls haven’t given up their persistent love of equities compared to Treasury's. Their new argument is that Treasury bonds may be providing superior appreciation, but stocks should be owned for dividend yield.

That, of course, is the exact opposite of the historical view, but in line with recent results. The 2.1% dividend yield on the S&P 500 exceeds the 1.50% yield on the 10-year Treasury note and is close to the 2.21% yield on the 30-year bond. Recently, the stocks that have performed the best have included those with above average dividend yields such as telecom, utilities, and consumer staples.

Then there is the contention by stock bulls that low interest rates make stocks cheap even through the S&P 500 price-to-earnings ratio, averaged over the last 10 years to iron out cyclical fluctuations, now is 26 compared to the long-term average of 16.7. This makes stocks 36% overvalued, assuming that the long run P/E average is still valid. And note that since the P/E has run above the long-term average for over a decade, it will fall below it for a number of future years—if the statistical mean is still relevant.

Instead, stock bulls point to the high earnings yield and the inverse of the P/E, in relation to the 10-year Treasury note yield. They believe that low interest rates make stocks cheap. Maybe so, and we’re not at all sure what low and negative nominal interest rates are telling us.

We’ll know for sure in a year or two. It may turn out to be the result of aggressive central banks and investors hungry for yield with few alternatives. Or low rates may foretell global economic weakness, chronic deflation and even more aggressive central bank largess in response. We’re guessing the latter is the more likely explanation.