Add another country to the European bailout list.
Over the weekend, Spain requested up to $125 billion in
bailout money to shore up its ailing banks, according to Bloomberg. Spain’s
banks and the country’s economy are reeling from the bursting of a massive
property bubble. Things are so bad in Spain that the country is back in
recession and nearly 25 percent of the country’s workers are unemployed,
according to The Wall Street Journal.
Spain matters because it’s the fourth largest economy in the
euro zone and if it goes bust, it may create chaos in euro land.
Fortunately, if all goes according to plan, the new bailout
money may be enough to reassure investors that Spain won’t go the way of
Greece. Speaking of Greece, the next big event in the ongoing euro zone debt
crisis takes place this coming Sunday when Greece holds a new election. Depending
on who wins, it could lead to “Grexit”—which means Greece leaving the euro. There
is no precedent for a country leaving the euro so if it happens with Greece,
we’re in unchartered territory.
Back in the states, Fed Chairman Ben Bernanke spoke last
week and said, “The situation in Europe poses significant risks to the U.S.
financial system and economy and must be monitored closely.” He went on to say,
“The Federal Reserve remains prepared to take action as needed to protect the
U.S. financial system and economy in the event that financial stresses
escalate.” While he didn’t announce another round of quantitative easing, the
markets were somewhat reassured that he might pull the trigger if the economy gets
much worse.
And let’s not forget China. They just announced a surprise
interest rate cut which “raised concerns over the state of the economy,” according
to MarketWatch.
So here we are again, monitoring the situation in Europe,
worrying about a hard landing in China, and analyzing whether the Federal
Reserve will ride to the rescue and print more dollars. It keeps our job very
interesting!
SOMETHING HAPPENED ON
NOVEMBER 18, 2008 THAT HADN’T HAPPENED IN 50 YEARS—what
was it and what are the implications for your portfolio?
Before we get to the answer, we need a brief review of
history. Up until 1958, the dividend yield on common stocks was higher than the
yield on bonds. This seemed to make sense because stocks were generally riskier
than bonds and in order to entice investors to buy stocks, they had to be
incented with a higher yield. But in 1958, that flipped. Stock prices rose, the
dividend yield fell and the yield on bonds became higher than stocks. For the
next 50 years, this relationship remained as bonds continued to out-yield
stocks.
Then, on November 18, 2008, the relationship reversed as stocks delivered a higher dividend yield than bonds. This was just a brief flirtation and the relationship flipped again shortly thereafter and bonds resumed their usual higher-yielding status.
Now, with the dramatic decline in bond yields, stocks are doing
that rare thing and delivering a higher yield than bonds, according to the Financial Times.
Here are several thoughts on the implications of stocks
yielding more than bonds.
(1)
Investors
are more risk averse. With bond yields extremely low, this
suggests investors are more concerned about safety than double-digit returns.
(2)
Bond
prices are at an extreme level. With 10-year Treasury yields having
recently touched an all-time record low, there may not be much room for them to
go lower—since 0 percent is the floor.
(3)
Government
intervention may be distorting the normal relationship between bonds and
stocks. Heavy bond buying by the Federal
Reserve could be artificially depressing bond yields and rendering some of the
traditional market relationships moot.
(4)
Investor
psychology may change over time. Prior to 1958, investors wanted a
higher yield from stocks because stocks were riskier. Then, over the next 50
years, bonds had a higher yield as investors became comfortable with the idea
that stocks offered a yield plus a
chance for capital appreciation—even with more volatility. And now, we’re back
to risk averse investors seeking higher yields from stocks.
Sources: Financial Times, BusinessWeek
From an investment standpoint, seeing a major change in a
long-term trend like the yield relationship between bonds and stocks suggests
we may be at an extreme level in bonds and stocks. And while nobody knows how
long it may take for this relationship to return to a more traditional level,
we’ll try to find ways to profit from it on your behalf.
Weekly Focus – Think About It…
“And so with the sunshine and the great bursts of leaves
growing on the trees, just as things grow in fast movies, I had that familiar
conviction that life was beginning over again with the summer.”
--F. Scott Fitzgerald, author
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