Zeev any thoughts on this post from Shellfish on the coupling/decoupling of stock aand bond prices?
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With bonds yields now at the level where they are, and the recession now deemed to be completely over by Wall Street (where forecasting is always nothing less than precise)I think it is important to look back to the end of other recessions to compare the yields on stocks relative to the yield on benchmark Treasuries. Those who believe that stocks will go on a rip-snorting bull run as they typically do when recessions end may be in for a surprise.
The current yield on the 10-year note is 5.31%. The S&P 500, depending on what yardstick one uses to determine earnings is yielding roughly 4-4.5%.
Here's the comparisons at other recession-recovery intervals over the past 50 years;
1953
10-year 2.30-3.11
S&P 500 11% (p/e 9)
1957-58
10-year 2.88-3.97
S&P 500 8% (p/e 12)
1969-70
10-year 6.04-7.91
S&P 500 7.5% (p/e 13-14)
1974-75
10-year 6.96-8.43
S&P 500 14% (p/e 7)
1980
10-year 9.78-12.84
S&P 500 16% (p/e 6)
1981-82
10-year 10.55-15.32
S&P 500 16% (p/e 6)
1990-1991
10-year 7.09-8.89
S&P 500 7% (p/e 14)
As one can see stocks often begin bull runs when they yield considerable more than benchmark Treasuries. Stock values rise as investors seek a position further out on the risk curve. Importantly, they do not necessarily become net sellers of bonds, rather the run in stocks has to be comprised of new money flows - otherwise the backup in bond yields would run smackdab into the falling stock yields and the bull run in stocks would exhaust itself.
When stock prices and bond prices move in opposite directions they are said to be decoupled. It may surprise some folks to find out that historically stocks have performed much more appreciably when stock prices and bond prices are coupled (moving in the same direction).Ed Bugos, another market analyst/commentator recently provided some crunched numbers on the returns that are traditionally made available when stocks and bonds repel. The periods in which stocks and bonds were coupled the longest produced the best returns in stocks( this should be self-evident if you think carefully).
Coupled 1920-28 +156%,1933-37 +136% , 1940-46 +95%, 1953-55 +49%, 1962-65 +61%, 1972-77 +13%, 1982-87 +170%, 1991-1995 +110%, 1997-Aug98 +57%
Since Aug '98 stock and bond prices have been decoupled and bull moves in one asset class have largely been accompanied by bearish moves in the other. The broad-based advances in the stock indices (early '01, post 9/11 thru Nov)have taken place alongside falling bond yields (recoupling). Everything else has largely been market declines or stagnating market chopiness. This correlates quite well with other periods of decoupling. In decoupled markets, stock market returns are consistently negative or well below trend ( the absolute best stock market return over the past century during decoupling occurred from 1955 to Oct 1962; a mere 44% over 7.5 years or less than 6% nominal return (ex. dividend) compunded annually.
Bugos also noted that since 1915 every major bull run in bonds preceded a bull run in stocks. Such an event did happen for a brief period after 9/11 when stocks collapsed, bonds rallied, and stocks subsequently rallied through November. At present, the two asset classes are decoupled with rallies in equities occuring alongside sell-offs in bonds and vice versa. The decoupling is an obvious sign of competition between the two asset classes, brought about by a shortgae of investment capital relative to the dollar volume of the two asset classes (Treasuries being the benchmark for all forms of credit instruments). It is easy to understand why there is currently not enough investment capital for both stocks prices and bond prices to move upward in unison. Some of reasons are as such;
-private sector credit growth remains robust (it requires significant investment capital to make auto and mortgage loans or to buy corporate convertible note offerings)
- federal government is expected to be net borrower for at least the next couple of years
- large percentage of the population already owns significant amounts of equities. Roughly 53 percent of household have holdings of stocks or equity mutual funds (only 13 percent did so back in 1981). The percentage of households who do not hold equities is probably greatly comprised of those who are living on fixed income budgets, poor, illiterate, or living the American dream paycheck-to-paycheck (heavily indebted)
-aggregate saving from disposable income is almost negligible
- private sector businesses are still running historically high financing gaps meaning they require a net flow of funds beyond their cash flow
-foreign inflows are highly correlated to existing current account deficits. Decreases in current account deficits would almost certainly slow the flood of investment capital from abroad |
