In a piece published on the Financial Post
, financial expert David Rosenberg explained how in current market conditions, investors are looking to stocks for fixed income and to bonds for capital gains.
He starts by explaining the forces at work in the bond market: the first wave of baby boomers is facing the prospect of living for decades after their 70s without sufficient savings, having lived through the dot-com and real estate bubble bursts. This will drive them more towards finding investment instruments that provide safe, consistent yield at a reasonable price. The timing is unfortunate, however, as the world is going through a paradigm of low yields.
“This is all the product of a world suffering from slow growth, deflationary pressure and the long arm of interventionist central banks,” he observes. “The average yield on the 10-year bond yield is just above 0.60% — so no income. And even the ‘safety’ is dubious now seeing as the number of AAA-rated sovereign credits in the past decade has been sliced from 15 to 10.”
This, he goes on to say, is the reason why investors are flocking to stocks. Despite the collapse in oil prices, fears of devaluations led by China, Brexit, and other hits to the stock market, major equity averages are reaching new highs.
“Maybe it’s because for these income-starved boomers, the equity market has become a more effective vehicle in terms of delivering income than the bond market,” he says, noting that both the S&P 500 and TSX have been delivering dividend yields that exceed the yield on their respective countries’ 10-year bonds.
On the other hand, he notes that coupon rates are now a minor component of the total returns on bonds: as an example, he reports that a 70-basis point decline in yield for long bonds this year corresponds to a total return of 18%. “So if you are buying government bonds, expecting a decent return at the current puny level of yields, you are chasing the price. You are a speculator focusing on price, not yield.”
He acknowledges that the situation is incredible, even though his commentary is peppered with hard numbers to illustrate its factuality. However, he does not believe that it will reverse itself in the foreseeable future.
“I believe that if the dividend yield-bond yield gap ever mean-reverts, as Bob Farrell’s Rule #1 assures us will be the case, it will not be through a return to higher interest rates, at least not any time soon.”
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