June 2012:- GLOBAL equities are offering the best value relative to bonds since the 2008- 2009 bear market. Such has been the flight into US, German and UK bonds that their yields have fallen well below inflation rate, and are negative in real terms.
In contrast, average global earnings yields – which reflect current profits of corporations and should rise in the long term because of profit growth – are well in excess of inflation rates. Dividend yields are not only higher than paltry bond yields, but also exceed the rate of inflation in most countries.
These are the views of veterans in the market including Jack Ablin of Harris Private Bank in Chicago and even Berkshire Hathaway’s Warren Buffett.
The earnings yield of America’s S&P index at 7.1 per cent and dividend yield of 2.7 per cent compares with only 1.64 per cent for 10-year US Treasuries and 2.45 per cent for 30-year bonds. The differential – wider than the depths of the equity slump late in 2008 and early 2009 – is evident in other countries as fearful asset managers and individual investors shun equities for bonds and cash with almost zero return.
The ultra-low bond yields – the lowest in over 60 years – are the result of a panic into so-called safe assets to flee perceived financial chaos in the eurozone and subsequent global recession and deflation.
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To be sure, Europe has severe problems, and some nations (notably Greece, Spain, Italy and Portugal) are in recession. But Germany, accounting for 28 per cent of the eurozone economy, is growing while France (26 per cent) is also slightly positive. North, South and Central America and Asia, including Japan, are achieving growth. China is slowing down, but even the most pessimistic forecasters expect growth to be at least 6 per cent.
Panic-stricken markets are focusing on a eurozone accounting for 15 per cent of the global economy, with the problem countries making up under 5 per cent, and ignoring the good news. The positive factors are a sharp decline in oil and other energy costs, a fall in industrial raw material and agricultural prices, and ultra-low short- and long-term interest rates.
Since unemployment is high, wage inflation is minimal while technological and communications advances are raising productivity for the vast majority of people who are working.
Companies and individuals in former bubble economies are paying back debt, and this is keeping down consumption. The austerity campaign of governments to cut spending is making jobless queues longer.
Medium- and longer- term, however, these moves pave the way to sounder economies, a rise in employment and demand, and an increase in corporate earnings and dividends. Instead of deflation, inflation is ever present around the world, according to the Organisation for Economic Cooperation and Development (OECD), while China’s inflation has fallen slightly to 3 per cent.
Such trends and easy- money policies around the world have kept economic forecasts positive, albeit at slower growth than during the boom years of 2003 to 2007. In such circumstances, well-managed corporations continue to report higher profits.
Although the uncertainty continues, the US, UK, Japanese and German equity markets are generally some 3 per cent higher than the low point at the beginning of June.
In contrast to those so-called safe haven assets, US Treasury bonds, German bunds and UK gilts have tumbled from their heights and capital losses have swept away their minuscule yields.
At their low point, 10-year US Treasuries had a yield of 1.45 per cent and 30-year Treasuries, 2.25 per cent. Losses on the 10- year bond are currently around 2.5 per cent and more than 5 per cent for the 30-year bond.
During the panic purchases of bonds, some asset managers and investors appeared to have forgotten a basic precept: bond prices fall when yields rise and the longer the period of the bond, the greater the loss. In the rush for yield and expectations that bond yields would remain low for a lengthy period or even fall further, investors appear to have forgotten the risk.
To put it more starkly, if a 10-year bond yield rose from 2 per cent to 3 per cent, the loss would be 8.6 per cent, while the loss on a 30-year Treasury bond would be 20 per cent.
Bond bulls maintain that the US Federal Reserve Board and the Bank of England are buying bonds to keep interest rates down while the European Central Bank is providing funds to central banks of stricken nations to do the same. Despite these efforts, however, they could be overwhelmed by sales from local and global investors who control multi trillions.
Of course, as recent weeks have shown, equities are also risky and in volatile markets there can be losses of 2-3 per cent in a single day. Vicious gyrations have made people fearful of equities, thus opening the door for investors who are prepared to shake off short-term fluctuations and buy good value for the long term.
© Neil Behrmann – author Trader Jack-The Story of Jack Miner