Relatively Speaking ...

September 9, 2019

Last week, we addressed the rising risk of bond investing in a world of low and negative interest rates. To recap, nearly $17 trillion in global debt now carries a negative yield to new buyers — in essence, you pay another party to hold your wealth with no expectation of a positive return. Good grief.

So what’s an investor to do? At its core, investing is about choices. Where’s the best place to earn a fair return with identifiable and measurable risk? For most of us, that’s a choice between stocks and bonds — and the proportional exposure to both. 

This brings us to an interesting position.

Bonds vs. Stocks: What is the Better Investment Right Now?

The chart below, courtesy of J.P. Morgan’s Guide to the Markets, shows that stocks are expensive relative to their own history. Compared to bonds, which are priced well up in the stratosphere, stocks look cheap. Note the box in the upper right corner. The top five statistics are standard measures of absolute value. For each measure, stocks are priced above their average level of the last quarter-century:

But consider the bottom item. ‘EY minus Baa Yield’ is essentially a comparison between stock and bond values in today’s market. EY is the Earnings Yield, the inverse of the Price/Earnings ratio. If a stock sells at 20 times earnings, its earnings yield is 5%. It represents your return on investment in a company, dividends and price changes notwithstanding. Baa Yield is the Moody’s category for lower investment-grade corporate bonds.

Again, these statistics tell us stocks are expensive by their own history, but cheap compared to bonds. That’s the reason for the re-emergence of the term “TINA” - There Is No Alternative.  We’re seeing more and more arguments in favor of buying stocks (despite their elevated values and slowing economic activity) because the primary alternatives are so much more expensive. Not the best argument I’ve ever heard.

So what’s the end game? As long as bond yields remain suppressed and the economy moves forward, stocks should produce reasonable results. But the case that equities are ‘the only game in town’ is built on a pretty precarious foundation. The idea of loading up on stocks because bonds are much more expensive carries an assumption that today’s bond environment — as irrational as it is — will continue. 

Maybe it will, maybe not. One thing I learned a long time ago is that valuation is not a timing device. It’s not to be ignored either. We will remain fully invested, but as always pay close attention to valuation — both absolute and relative. 

To see how these issues affect your portfolio and long term planning, talk to your Advisor today. We want to ensure our actions match your goals.

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