The current brouhaha started last Wednesday when the Financial Times suggested the “death of equities.” Negative real returns over more than a decade, two major stock market declines and increased regulatory pressures to withdraw from stocks are all contributing factors. Institutional equity allocations are down and retail participation is limited.
Meanwhile, bonds have rallied for three decades, fueled most recently by central banks willing to give money away (literally) in order to try to stimulate a global economy still in the throes of difficulty stemming from the worldwide credit bubble and the financial crisis from which it sprang. As I noted in my 2012 Investment Outlook, it’s tough to fight the Fed, and the Fed keeps claiming that it will keep giving money away for the foreseeable future. Thus, according to FT, “[c]ompared with bonds, stocks have not looked so cheap for half a century.” Indeed, the dividend yield on U.S. stocks is today 1.97 percent – above the 1.72 percent yield on 10-year U.S. Treasury notes.
Politics and regulation have been at least partly behind the markets’ preference for bonds to stocks of late. As FT points out, “governments have changed tax treatments on dividends; insisted companies and banks value assets as they are traded in the markets rather than on the basis of models and assumptions; altered accounting rules on how companies value pension promises to employees; and prodded pension managers to buy bonds by forcing them to match their assets to future liabilities.”
Retail investors have their own part to play in this drama. In the U.S., flows into bond funds have exceeded flows into equity funds every year since 2007, with outright net redemptions from equity funds in each of the past five years.
According to FT, while some hope that the cycle will turn, “[f]ew people doubt…that the old cult of the equity – which steered long-term savers into loading their portfolios with shares – has died.”
Interestingly, FT acknowledges that this declaration of death “is stunning in light of overwhelming evidence that, in the long run, equities outperform. From 1900 to 2010, they beat inflation by 6.3 percent a year in the U.S., according to a widely used benchmark maintained by London Business School, compared with only 1.8 percent for bonds.”
Earlier this year, Goldman published a report arguing that “[g]iven current valuations, we think it’s time to say a ‘long good bye’ to bonds, and embrace the ‘long good buy’ for equities as we expect them to embark on an upward trend over the next few years.” Even so, that argument is more about bonds being overpriced than about the value of equities.
This entire discussion harkens to the famous 1979 BusinessWeek cover that proclaimed The Death of Equities ahead (if by almost exactly three years) of one of the great and sustained bull markets for equities the world has ever known. With apologies to Mark Twain, such reports of the death of equities were then, as now, greatly exaggerated (see below).But what does the death of “the cult of equities” really mean? According to one writer of the FT piece, it merely means that equities should no longer be presumed to trade at a lower yield than bonds.
The most comprehensive examination of this idea is Equity Cult Still Dying, published earlier this month by Rob Buckland, Citigroup’s Chief Global Equity Strategist. Rob proclaims that the equity cult is “still dying.” Demographics works against equities today because Baby Boomers are retiring and are potential (though perhaps overstated) sellers of equities, inflation-protected bonds exist to hedge against inflation (equities had to do that job once upon a time), and equities are now heavily correlated with other assets in an era of instant and global communication. Thus he sees calls for “an imminent return of the equity cult” as “premature.”
Michael Santoli of Barron’s offered his rebuttal on Saturday, asserting that FT’s observations were late and the ultimate conclusions aren’t all they are cracked up to be. But he isn’t declaring the start of a bull run either.
Thus even some of the longer-term optimists are not yet convinced that it’s time to load the boat with equities for reasons that include tremendous governmental and personal debt which overhangs the markets at all levels worldwide. Seeing bonds as rich is a far cry from seeing stocks as cheap. I am in this camp.
My view has not changed since I first laid it out at the beginning of 2011 (and I held it long before that). Since 2000 we have been suffering through a secular bear market, subject to extreme cyclical swings in both directions. I hope that – as with the famous BusinessWeek cover – the current equities death watch is a leading bullish indicator or even the inflexion point to a new secular bull market. But I doubt it. Despite decent P/Es, other valuation levels (P/B, PE10, Q) as still too high. Even so, as my friend Tadas Viskanta sagely points out, “the seeds of a generational bottom or a new secular bull market are being sown. Unfortunately with these seeds we do not know how long it will take them to germinate.” In the meantime, investors would be wise to preserve capital by managing risk first while still looking for ways to invest profitably and well in the meantime.
When the next secular bull market is underway, we should all be prepared to load up on equities. But I don’t think we’re there (yet).
Be careful out there.