What are Bonds saying about Equities?
November 26, 2013
Chad Karnes, Chief Market Strategist
"There is no investment alternative" is the new popular Wall Street axiom in the latest attempt to get the public to double down on equities by shifting assets out of bonds. But is there really “no alternative to equities”?
A Low Yield World
The general premise behind the TINA (There is No Alternative) theory is that with such low interest rates, the only logical place to park money is in the riskier equities. Basically, low interest rates provide low returns, and the low yields aren’t worth the risk in owning bonds.
But, low interest rates also affect equities as the S&P 500’s dividend yield also sits at an all time low, below 2%. So although interest rates are low, equity dividends are also low, making equities no more desirable than Treasuries from a dividend standpoint.
Given the risk versus reward dynamic, buying equities for such low dividends may actually be a downright bad decision based on current prices and discussed below, but, first, here are three things those reaching for yield seem to be forgetting:
-Treasury and other debt yields can rise very quickly (as has been the case since May when some Treasuries doubled in price). When Treasury rates rise, they become relatively more attractive than they were previously;
-Dividends and dividend growth can be slashed by companies just as quickly as yields can rise (as was the case in 2008 and most recessions in the past when companies slashed dividends);
-With dividend yields also at all time lows, capital losses can more than wipe out a year, two years, or even five years of dividend gains instantly. The Utilities Select Sector SPDR (NYSEARCA:XLU) was yielding 3.6% in April but fell 10% through June. It has still yet to recover April’s highs and now has a YTD loss for those April buyers- including dividends. With dividend yields at all time lows, this risk has never been higher in owning stocks for dividend yields alone.
The following chart was provided in the December 2013 edition of the ETF Profit Strategy Newsletter (released on 11/22) and shows why the TINA (there is no alternative) crowd is likely to be very wrong at exactly the wrong time.
At current prices, U.S. stocks (NYSEARCA:SPY) are reaching the most expensive levels they have ever seen when priced in comparable Treasury prices (NYSEARCA:TLT). The only other times equities were this expensive compared to Treasuries was early 2000 and late 2007, just before major equity market declines kicked off and the stocks versus bonds ratio swung back toward equilibrium.
In reality, the TINA crowd is diving head first into equities when Treasuries are a better relative buy. The chart above shows that compared to Treasury prices, equities are reaching the upper extremes of valuation associated with recent major market tops.
Insult to Injury
Even worse, rising interest rates make the current equity valuation situation worse. As rates rise, bond prices fall, making equities that much more expensive compared to alternatives. It also means that as would be expected, when the markets move back to equilibrium equities will fall much faster than Treasury prices.
But, rising interest rates are something we have been prepared and able to get ahead of.
In May we were warning that a rising interest rate environment was around the corner and our Technical Forecast readers were provided analysis, charts, and trade alerts like:
“Continue to switch bonds into shorter durations” and “shorter term bonds such as the iShares 1-3 year Treasury bond (NYSEARCA:SHY) or the Barclays 1-3 month T-Bill (NYSEARCA:BIL) remain the safer place for your bond money”.
Those who shifted their Treasury bond exposure to shorter durations as we suggested since then have saved over 9%.
Practically speaking, as interest rates rise (NYSEARCA:STPP), Treasuries become more attractive as a yield investment. Curiously, the TINA crowd wants more yield but they're looking for it in the wrong place!
At current prices for equities, bonds are much more attractive in price, and a continued rise in interest rates will only make them even more so.
The ETF Profit Strategy Newsletter exposes the mistakes of the TINA psychology and dives into the tradeoff between equities and bonds along with high profit opportunities in other major asset classes.
Follow us on Twitter @ ETFguide