Barron's does a piece on the corporate yield vs. stock PE multiple that I've harped on. I disagree with the conclusion. Forsyth says stocks are priced for recession, bonds for depression, and that it resolves by bonds moving up (IOW, we're only going to have a recession.) To the contrary, I think bonds have it right, and probably adequately reflect the outsized risk that exists in the year ahead. IMHO the discrepancy needs to be resolved by stocks going ahead and eventually discounting depression.
There's more of this malarkey about interest rates going down further. Hogwash. Market rates haven't gone down, and they aren't *going* down. Fed rates are irrelevant at this stage. All that matters are market interest rates, and the Fed is engaged in a futile effort to convince the market that they should go down. All the Fed programs to buy debt, the TARP, all the interventions are just pi$$ing in a flood. The Invisible Hand rules.
Be that as it may, he cites good statistics for the relevance of the Baa bond yield as the ultimate yardstick for stock earnings multiples. So, as I've mentioned before, watch that Baa yield. When PEs start to exceed the Baa yield - either by bonds climbing or stocks falling further - it's time to begin gradually accumulating stock. Just be prepared to hold your breath underwater for a year or more - stocks taken to the bargain basement early in the bear could stay there for a long time. Don't know about you, but it would be tough for me to sit still in AA for a year going nowhere while I watched overpriced, overowned fat piggies like SCHW, JNJ, PG, MMM, MCD, and KO go diving for value...
online.barrons.com
Bonds Priced for Depression Beat Stocks
By RANDALL W. FORSYTH | MORE ARTICLES BY AUTHOR
Investment-grade corporates may offer stock-beating returns.
THE STOCK MARKET IS PRICED FOR a recession, but the bond market is priced for a depression. So says Rob Arnott, the brainiac who heads Research Affiliates, an institutional advisory.
That's not hyperbole. Corporate bonds rated Baa or triple-B, the low end of investment grade by Moody's and Standard & Poor's designations, offer the biggest yield premium since the early 1930s, notes RBC Capital Markets.
That's a problem for pulling the economy out of the credit crisis, but an opportunity for investors. Indeed, investment-grade corporates with near-record premiums arguably offer better return potential than common stocks, especially relative to their risks. "I haven't seen this many markets offering double-digit opportunities since 1989-90 or ever so briefly in 2002," says Arnott.
Part of it reflects the sheer weight of numbers. Corporates rated Baa yield about 550 basis points (5.5 percentage points) more than comparable Treasuries, nearly half again the spread in the 2002 post-WorldCom-Enron debacle and twice the average of post-war recessions.
You have to go back to the early 1930s, when Baa corporates yielded 700 basis points over Treasuries, to find a comparable situation. And notwithstanding all the hyperventilation in the media that this is worst financial crisis since the Great Depression, there's never been such a full-court response to the threat of debt deflation -- the $700 billion TARP, the bailout of Fannie Mae and Freddie Mac, the likelihood of trillion-dollar deficits and a doubling in the Federal Reserve's balance sheet in just over two months.
Whether this is the road to enlightenment or perdition is a question I'll leave to others. It is what it is. All of Washington's horses and all of its persons are arrayed to prevent the 1930s from happening again, for better or worse. This suggests that corporate bonds shouldn't be priced as if it were.
Part of the problem is that prices are being depressed by sellers in an illiquid market. The last quote on $100,000 bonds will determine the value of a $1 billion issue, depressing the remaining $999.9 million.
That's produced much pain for corporate-bond investors, such as Dan Fuss, the market veteran who heads the Loomis Sayles Bond Fund (ticker: LSBRX) and also is its biggest shareholder. So he's been hit by the 25.89% year-to-date negative return, according to Morningstar.
[Global tables]
"A Return to Normalcy": In this Election Week, Warren G. Harding's slogan described the money markets as Libor for dollar and other currencies continued to move closer to usual spreads from central-bank rates.
The Loomis Sayles Bond Fund yields 9.78% on a portfolio that is primarily invested in what Fuss deems the sweet spot of the market -- single-A and triple-B corporates yielding 10% to 12%. About a quarter of fund is in junk bonds, where he's picking up yields upwards of 18%.
More importantly, Fuss says, these yields are on deeply discounted bonds. So, buyers of these bonds, which are selling for 60 or 70 cents on the dollar, will participate in their eventual recovery, earning capital gains along with hefty current yields.
"I prefer discount bonds to admittedly cheap equities," especially as corporations delever and rebuild balance sheets, he continues. The best use of corporate cash now may be to buy back bonds at discounts, effectively discharging debt for pennies on the dollar, Fuss says. It's a reversal of the past quarter-century, during which companies took on debt to do leveraged buyouts or repurchase stock.
That's happening, but because of the nature of the corporate market, it's a poker game with companies not wanting to tip their hand. That would immediately boost the prices of the bonds they want to buy on the cheap.
Meanwhile, the stock market hasn't fully priced in the likely decline in earnings ahead, according to Michael T. Darda, chief economist of MKM Partners in Greenwich, Conn. At major market lows, stocks' earnings yield (the inverse of the price-earnings ratio) exceeded or almost equaled that of Baa corporate bonds.
Even based on conservatively estimated 2009 earnings on the S&P 500 of $68.50 -- about a quarter less the Wall Street consensus -- the S&P trades at a P/E of 12.4. That's an 8.06% earnings yield, 86% of the 9.39% Baa corporate yield.
In 1982, the S&P bottomed at a 6.6 P/E, a 15% earnings yield, close to the 16.32% on Baa corporates. In 1974, the 7.9 P/E resulted in a 12.66% earnings yield, well over the 10.48% Baa yield. In 1932, the 5.6 P/E equated to 17.86% earnings yield, more than half again the 11% Baa yield.
Fuss also opines that investors increasingly will be starved for yield, which will force them out of Treasuries and into riskier but vastly more remunerative corporates.
Interest rates are likely to continue to fall, with the futures market pricing in another half-point cut in the fed-funds target, from 1% currently, after last week's seemingly endless parade of horrible economic numbers. The yield on the benchmark 10-year Treasury note dropped 18 basis points, to 3.78%, but the market was under pressure late in the week amid worries about the federal government's record borrowing needs.
`BC |
