The yield on the 10 year Treasury closed at 2.03% down from 2.13% at year end. I shares Core U.S. Aggregate Bond Index – AGG, closed up 1.5%. Gold closed lower on the year while WTI oil has rebounded sharply from its $44/bbl. January and March lows.
We are in the midst of earnings season. With 201 companies reporting as of April 24th, 73% were above the mean estimate while only 47% reported sales above mean estimates. The 12 month forward P/E ratio is 16.8 x S& P 500 estimates of $123.83 according to Factset.
The Euro currency has rallied 7% off its March lows after a 17% plunge from the first day of 2015.
German 10 year bund yields settled at 0.36% after dropping to merely 0.7 %.
Switzerland has a negative 0.02% yield out 10 years and Japan pays a paltry 0.33%.Central Bank demand for sovereign bonds exceed issuance in major developed economies.
Bill Gross says shorting the German Bund may be the greatest opportunity of his lifetime! Negative yields are a certain loser for savers.
We conclude that with historic low yields, stocks are better bargains than bonds and perversely may be less risky.
These quotes from the WSJ illustrate the principal dilemma faced by investors. “The yield on the U.S. Treasury 2-year note is 0.52% and has averaged 0.73% since the beginning of 2008. In contrast, from 1988 through the end of 2007, the average yield on the two-year Treasury note was 5.23%....At the end of 2006 the average yield on a one-year CD was 3.8% and the average yield on a five-year CD was 4.1%, according to Bankrate.com.
Persistent low rates have forced investors into dividend paying equities. 47 % of S&P 500 stocks have dividend yields greater than the 10 year U.S Treasury yield.
Currently U.S. treasuries yield 2.03%. We don’t have strong conviction whether 10 year Treasuries will go 50 basis points higher or lower by year end.
We believe 2% inflation targets in the U.S., Europe and Japan will be a stretch in 2015. We do however expect better GDP and profit numbers in the second half of 2015.
With a forward estimate of $123.83 on the S& P 500 index, we calculate as follows:
123.83 of earnings / 2085 the SPX close on April 30 the = 5.9 % earnings yield.
This is a risk premium of 3.87 percent over the 10 year note, enough to compensate for holding riskier shares.
Other methods to measure value argue stock prices may be too high but low rates are here for some time to come and underpin prices as earnings and dividends both move higher.
Stocks look attractive in Europe and Japan where weak currencies and massive QE monetary programs are driving savers and pension funds into stocks given near zero bond yields. China has moved toward easy money and it has ignited a heretofore under performing market.
The wealth gap continues to widen as the rich have gotten richer as owners of shares, bonds, and high end urban real estate. Investor’s Business Daily points out that had we experienced a Reagan like economy with annualized 4% GDP versus the 2% annual pace we have seen since 2009, the U.S. would be richer by $2.5
Trillion in GDP terms or nearly $20,000 for an average American household.
Lack of investment due to low capital spending, weak employment and slow wage gains are the result of higher taxes, burdensome regulation, and low confidence in future growth.
Many nervous investors have stayed on the sidelines due to mistrust of markets and policymakers. This scenario leads us to conclude we will experience a longer than average economic and market cycle.
2015 is unfolding much like 2014 with GDP adjusted for price changes, up 0.2% in the 1st quarter.
The U.S. Federal Reserve Bank is preparing to raise in short term rates as economic data is expected to strengthen later this year.
Stocks should be able to weather turbulence created by higher rates, if they are modest and gradual. Stocks tend to climb after the first rate hike.
Needless to say too much U.S. dollar strength, the Iranian nuclear negotiation, Russian aggression and the
Al Qaeda/ ISIS war on the civilized world are possible roadblocks to higher prices.
Doug Coppola
John Coppola
May 1, 2015
Communication is for informational purposes only & doesn’t constitute offer to sell or a solicitation of an offer to purchase any interest in any investment vehicles managed by CFA or an associated person or entity. CFA does not accept any responsibility or liability arising from the use of this communication. No representation is being made that the information presented is accurate, current or complete, and such information is at all times subject to change without notice. We do not provide legal, accounting or tax advice. Any statement regarding legal, accounting or tax matters was written in connection with the explanation of the matters described herein & not intended or written to be relied upon by any person as definitive advice. Any discussion of U.S. tax matters contained within this communication is not intended to be used and cannot be used for the purpose of avoiding penalties that may be imposed under applicable Federal, state or local tax law or recommending to another party any transaction or matter addressed
