It has been three decades since Business Week proclaimed “The Death of Equities” on its cover. That 1979 obituary for the stock market, published when the Dow Jones industrial average languished at a mere 875, became a symbol of an age of doubt. So shattered were ordinary Americans by gas lines, recessions and double-digit inflation that they resorted to pulling cash out of equity mutual funds — for eight straight years.
Investors in the ’70s were stunned by an alarming rise in volatility. The comfortable, ordered system of international exchange, in place since the Bretton Woods accord at the end of World War II, had come apart, leading to violent fluctuations in currency values. Grain shortages sent food prices soaring, and memorably, OPEC put the squeeze on oil. The cumulative effect was a loss of faith in money itself. (Doomsayers urged redeploying assets into metals, oils — anything other than paper.) Inflation, a virulent form of instability, terrified investors, who duly stayed on the sidelines.
It may seem strange to be drawing parallels to the ’70s now — prices are so stable that the fear is of deflation. Yet there is no mistaking the ’70s-ish gloom that has overtaken Wall Street. The trauma of the financial crisis has yet to be dispelled. It is not just Lehman Brothers and Bear Stearns that have disappeared but an ethos of confidence in long-term investing.
Though stocks remain well above 2009 lows, investors are withdrawing money from U.S. equity funds for the third straight year. Dispiritingly, investors are shunning attractively priced stocks in favor of bonds (both government and corporate) on which the returns are anemic.
The current crisis was inspired by financial shocks rather than commodity disruptions. But the result is a familiar malaise. The international monetary system, hobbled by imbalances and deficits, seems broken. Another echo is the sense that the sheer number of economic problems precludes a solution to any one of them. In 1979, an investment analyst was heard to despair, “The future is clouded by many ugly questions.” Today analysts despair over high unemployment, failing mortgages, government deficits, impotent political responses, a weakening economy and a similar litany abroad. In another echo, Chicken Little has staged a comeback. In the early ’80s, an energy consultant forecast — in this magazine — a “high probability” of an oil shock in which “the basic legitimacy of our political system might be called into question.” Today’s version is hyping the possibility of a stock-market crash. Albert Edwards, an investment strategist for the French bank Société Générale, has said he expects a “bloody, deep recession” that produces a stock-market collapse of at least 60 percent. He recently drew a crowd of 600.
Of course, any such forecast could prove right. But it is generally more lucrative to sell prophecies of doom than to act on them. What the herd tends to overlook is that stocks are not — except perhaps in the very short term — a bet on the odds of an apocalypse, nor are investors in securities rewarded for their prowess as macroeconomists. The real challenge of investing is so prosaic it is often forgot. Stocks are simply a claim on future corporate earnings: if you can buy those claims at a discount, you should do well.
Wise men will disagree on the meaning of “at a discount.” But American business is profitable even today. And the Standard & Poor’s 500 stock index is trading at only 12 times the expected earnings of the underlying stocks over the next year. Inverting that ratio, stocks have an earnings yield of 8.5 percent. (Each $100 of stocks is backed by $8.50 of expected earnings.)
Compare that with Treasury bonds, on which the yield is a dismal 2.58 percent. Short-term bond rates are well under 1 percent. The gap between 8.5 percent and 2.58 percent represents a striking reversal. For most of the past generation, bonds yielded more, sometimes much more, than stocks. The theory was that since earnings would grow over time, investors in stocks would accept a lesser return at the outset. They would pay for growth.
Now investors are flocking to bond funds; they are paying to avoid uncertainty — to avoid the prospect of financial Armageddon. Americans whose attitudes toward investing were shaped by bibles like “Stocks for the Long Run” seem to have undergone a fundamental rewiring. Perhaps when you are out of a job, the long run doesn’t matter. “People would rather overpay for bonds than underpay for stocks,” says David Kelly, a strategist for J. P. Morgan Funds. “It’s a function of years of very miserable stock returns. And just a general fog of gloom over the country right now.”
In markets, of course, gloom is no more permanent than boundless optimism. For the previous generation, the turn arrived in 1982 — three years after “The Death of Equities.” It was fueled by corporate raiders, who could not resist seeming bargains on Wall Street and whose takeover bids sent share prices soaring.
There is no telling how long the present funk will last, but there are signs it could end in similar fashion. Corporations in droves have been exploiting low interest rates by borrowing. I.B.M. raised $1.5 billion at a record-low interest rate of 1 percent. It used a chunk of its haul to acquire a software vendor. Borrow cheap and buy low.
So far, ordinary consumers remain too in hock or too frightened to do either. What money they have is going into bond funds. “The individual investor is saying no más to equities,” notes Robert Barbera, the chief economist for Mount Lucas, a private investment firm. It is hardly a stretch to say that the recovery of companies like I.B.M. is being fueled by the willingness of small investors to lend to them on the cheap.
Most of the people buying bond funds do not use a calculator in making investment decisions. They are captives, understandably, of their experience. But gloom and doom also has its price. It would be a sad twist if people were to mirror their recent excessive risk-taking with excessive caution now.
Roger Lowenstein, an outside director of the Sequoia Fund, is a contributing writer and the author of “The End of Wall Street.”
Aug. 16 (Bloomberg) — Investors are moving more money than ever before out of stocks and into bonds, widening a valuation gap and convincing JPMorgan Chase & Co. and BlackRock Inc. that now is the time to buy equities.
About $33 billion flowed out of funds owning U.S. shares this year even as the economic recovery sent free cash flow for American companies excluding banks to 6.8 percent of their market value. That’s the highest level compared with corporate debt yields since 1960, Credit Suisse Group AG data show. About $185 billion was sent to bond funds through July 31, the most on record, according to the Investment Company Institute.
The biggest money managers say concern the U.S. will slip into a recession is overblown and that individuals piling into fixed-income securities for their relative safety are making a mistake. David Kelly, who helps oversee $445 billion as chief market strategist for JPMorgan Funds, says record low yields show there’s too much demand for bonds and aren’t a sign the economy is headed for the second recession in three years.
“People would rather overpay for bonds than underpay for stocks,” Kelly said in an interview from New York. “It’s a reflection of an extraordinary prejudice. If people are at an emotional extreme, it means that at some point there’s got to be reallocation of cash away from the bond market toward the stock market. Ultimately, it’s bullish.”
Weekly Decline
The Standard & Poor’s 500 Index fell as much as 0.9 percent today and gained 0.3 percent before ending with a less than 0.1 percent advance to 1,079.38 at 4 p.m. New York time.
Stocks dropped last week, with the S&P 500 losing 3.8 percent to 1,079.25, on speculation the global economic recovery is faltering. Investment-grade corporate bonds returned 0.54 percent, including reinvested interest, according to Bank of America Merrill Lynch’s U.S. Corporate Master index. A four- month rally in Treasuries has pushed yields on 10-year notes down to 2.57 percent, compared with 4.01 percent on April 5, data compiled by Bloomberg show.
The Federal Reserve on Aug. 10 reversed plans to exit from monetary stimulus and said it would keep its bond holdings level to support an economic recovery, which it said is weaker than anticipated. Cisco Systems Inc., the world’s largest maker of networking equipment, forecast sales on Aug. 11 that missed analysts’ estimates, while unemployment claims rose in a Labor Department report on Aug. 12.
Yanking Funds
Investors have pulled money from U.S. equity funds in 10 of 17 months since the start of a rally in March 2009 that sent the S&P 500 up as much as 80 percent. This year’s withdrawal, the biggest since 2008, came as worker firings and reduced capital spending pushed company cash to $836.8 billion, according to S&P. Non-financial companies are yielding 0.8 percentage point more in free cash flow than the average interest rate on investment-grade corporate bonds, according to Credit Suisse.
About $185.3 billion was invested in bond funds in 2010 through July 31, according to ICI. That’s the most for the first seven months of any year since 1984, when ICI started compiling the data. The spending has helped push the average investment- grade bond price to more than 110 cents on the dollar, the highest level in more than six years, Bank of America Merrill Lynch index data show.
“Stocks are a screaming buy relative to bonds,” said James Paulsen, chief investment strategist at Wells Capital Management in Minneapolis, which oversees $342 billion. “The valuation divergence makes sense if a deflationary abyss is coming. If the economy improves, the gap will look silly.”
Earnings Growth
Earnings for S&P 500 companies may rise 36 percent in 2010 and 16 percent in 2011, the largest two-year advance since the period ended in 1995, according to the average analyst projections in Bloomberg data. Economists predict a 3 percent expansion in U.S. gross domestic product this year, the fastest since 2005, Bloomberg data show.
A moderate recovery combined with attractive valuations mean Philip Morris International Inc. and EMC Corp. are cheap enough to buy, said Keith Wirtz, the chief investment officer of Fifth Third Asset Management Inc. in Cincinnati.
“Some of these equity investments are providing earnings yields that are extremely competitive relative to the bond market,” said Wirtz, who oversees $18 billion. “Given the uncertainties of 2011 on the macro picture, investors will look for returns in the large and quality segment of the market.”
Cash From Operations
Philip Morris trades at 14 times reported earnings, below its record ratio of 17.6 in 2008, Bloomberg data show. The New York-based company generated $3.68 a share in free cash flow, or cash from operations left over after capital expenditures, during the past year, giving a yield of 7.1 percent. Analysts estimate earnings at the world’s largest publicly traded tobacco seller, which raised its full-year profit forecast last month, to rise 15 percent this year and 10 percent in 2011.
EMC, the world’s biggest maker of storage computers, said last month that second-quarter profit more than doubled as businesses in the U.S. and Europe boosted spending on information technology. Its free cash flow yield is 7.7 percent, according to data compiled by Bloomberg. Hopkinton, Massachusetts-based EMC trades at 23.8 times earnings, down from 35.8 in 2007.
The S&P 500 trades at 14.4 times annual earnings, compared with an average of 16.5, according to data compiled by Bloomberg that goes back to 1954. Normalized earnings-per-share growth and price-to-earnings ratios for the gauge over the next 10 years will match their median rates since 1957, said Robert C. Doll, vice chairman at BlackRock, which oversees $3.2 trillion.
10 Predictions
Doll, in an Aug. 2 statement called “10 Predictions for the Next 10 Years,” forecast that U.S. stocks will return 8.1 percent a year including dividends and the S&P 500 will almost double to 2,034 by the decade’s end. He also said that returns in stocks will likely outpace U.S. Treasuries and cash.
“We’ll have enough earnings growth coupled with valuations,” Doll, chief equity strategist at the New York- based firm, said in an interview. “That’s an environment where stocks outperform. If the world is anything close to normal, stocks are more interesting than bonds.”
While bond valuations are rising, investors are buying. The top 10 lowest-yielding U.S. corporate new issues in history have been sold in the last 14 months as yields on 2- and 3-year Treasuries fell to record lows, Deutsche Bank AG strategist Jim Reid wrote in an Aug. 4 note.
IBM, J&J Sales
International Business Machines Corp., the world’s biggest computer-services company, raised $1.5 billion on Aug. 2 at the lowest interest rate on record. The 1 percent, 3-year IBM notes have the lowest coupon of the more than 3,400 securities in the Barclays Capital U.S. Corporate Index of investment-grade company debt. Johnson & Johnson sold $1.1 billion of bonds on Aug. 12 at the lowest interest rates on record for 10-year and 30-year securities.
The valuation gap between bonds and stocks may widen further on investor concern about deflation, said Mohamed A. El- Erian, chief executive officer of Newport Beach, California- based Pacific Investment Management Co., which runs the world’s biggest bond fund.
“A small increase in the probability of a deflation can have a material impact on markets even if the overall probability of the scenario remains low,” El-Erian wrote in an e-mail. “The greater the concern with deflation, the higher the vulnerability of the lower parts of the capital structure for both companies and economies. The risk premium in markets goes up disproportionately.”
Options Insurance
The Chicago Board Options Exchange Volatility Index, derived from prices investors pay to protect against losses in the S&P 500, jumped to 26.24 on Aug. 13, the highest level in a month, as global stocks slumped. The VIX remains down from this year’s closing high of 45.79 on May 20.
“Investors have not recovered from the trauma of the financial crisis,” said Howard Ward, fund manager at Gamco Investors Inc., which oversees $26 billion in Rye, New York. “This would lead you to buying bonds, at what is likely a dangerous inflection point looking beyond the next six months, assuming no double-dip. It takes a real believer in the rewards of equity investing to commit funds in this stormy environment.”
To contact the reporter on this story: Rita Nazareth in New York at rnazareth@bloomberg.net.
While Research in Motion has been busy all week trying to defuse a rapidly accelerating international controversy over its encryption codes that sent shares tumbling, the Waterloo-based tech giant found some time on Tuesday to launch its long-awaited response to Apple Inc.‘s iPhone 4: the BlackBerry Torch 9800.
Reaction has been decidedly mixed for the new slider smartphone, but for Gus Papageorgiou, analyst with Scotia Capital, the BlackBerry Torch is RIM’s Best. Phone. Ever.
“We believe this is the best BlackBerry ever released. With strong carrier support, a new App World and new developer tools, we believe the BlackBerry Torch will be a strong seller worldwide,” Mr. Papageorgiou said in a note to clients.
After handling the phone, Mr. Papageorgiou gushed about its solid look and feel, which while similar to the Palm Pre is considered a “superior” experience.
“We were very much impressed with how RIM incorporated touch into the interface and allowed for significant functionality from the home page, while maintaining the popular keypad shortcuts that its current subscriber base has become accustomed to,” he said.
Mr. Papageorgiou also liked the phone’s social feeds app, which consolidates access to Facebook, Twitter, LinkedIn, and other buzzy social media hotspots.
However, he acknowledged that there is a “lack of a showcase feature or stellar hardware” which may create headwinds for the Torch.
“We fear pundits will not appreciate the productivity enhancements made in this OS and will instead focus on the device’s technological shortcomings,” he said.”Although the Torch’s lacklustre hardware specification will likely prove to be problematic in gaining the blogging community’s support, we believe AT&T’s strong promotion … and RIM’s dedication to improving app development will drive strong device sales.”
Of course, whether this phone is any good and whether it is good enough to combat the iPhone are two separate questions.
It looks like RIM has that covered as well, with AT&T exclusively offering the phone at the moment and about to roll out an extensive promotional campaign.
“The Torch will be positioned as its flagship messaging devices, whereas the iPhone is positioned as a media consumption device given its integration with iTunes,” he said. “When asked about iPhone adoption amongst enterprise, AT&T commented how large enterprises were not adopting the iPhone due to the lack of native device management and because of the significant installed base of BlackBerry Enterprise Server. We believe RIM has a strong defensible position in the enterprise space and will make inroads to the consumer segment with its new media-focused platform.”
Mr. Papageorgiou recommends investors buy into RIM before it takes off, arguing the stock is trading at an undervalued 8.2x price/earnings ratio. He rates RIM a Sector Outperform with a price target of $117.
Chaos prevailed on world equity markets yesterday and it continued into overnight trading in Asia and Europe. The Dow Jones Industrial Average plunged 700 points in the 15 minute period after 2:40 PM EDT. Was it panic selling or a technology glitch? Probably both! Stop loss selling triggered an avalanche. The recovery was equally eerie. For GIM, it was business as usual…
Featured Pro: Jonathon A. L. Gold, B.Comm., FCSI, DMS, CFA and President of Edmonton-based Gold Investment Management Ltd. (GIM), a registered portfolio manager and investment counsel.Investment Strategy: “GIM’s investment strategy is described as semi-passive. We aim to capture the best of active management and indexation. Model portfolios offer distinct risk levels centered around core themes: semi-passive core strategy; study of macro environment, fundamentals and technicals; active overlay including tactical and strategic trading; select currency hedging; no large directional bets; and agnostic on markets – not overly concerned with market direction.
GIM’s five investment commandments are:
(1) buy great stocks;
(2) buy dividend paying stocks;
(3) don’t speculate – that’s the other guy’s problem;
(4) keep a cash reserve and buy when others panic; and,
Merry Christmas! Best wishes for a healthy and prosperous 2010.
Yours truly,
GOLD INVESTMENT MANAGEMENT LTD.
In Jasper Park, A.Y. Jackson, 1924, oil on canvas
Thomson Collection at The Art Gallery of Ontario, Courtesy of the Estate of the late Dr. Naomi Jackson Groves
Every year, since 1995, we’ve run on our front page — and now on our home page, too — a piece of art from the Thomson family’s collection.
It started as a holiday greeting to our readers and has become a bit of a Canadian tradition. This year, we offer you holiday cheer and inspiration with In Jasper Park, an extraordinary work by A.Y. Jackson. This tradition was started by The Globe and Mail’s late controlling shareholder, Kenneth Thomson, who had a passion for many things, among them Canadian art and newspapers. Not only was he a great collector; Mr. Thomson believed that these works should be shared by everyone. Thus, he donated more than 3,000 pieces to the Art Gallery of Ontario, and funded a redesign of the gallery by Toronto native Frank Gehry to — among other things — house the Kenneth and Marilyn Thomson collection.
The Globe’s visual arts critic Sarah Milroy explains the artwork’s significance
By 1924, A.Y. Jackson had already climbed a few peaks in his life. He had fought in the First World War and after being wounded, worked as a war artist. Prior to that he studied painting at the Académie Julian in Paris, where he had imbibed the nectar of impressionism, and had returned home to forge what would become the Group of Seven with his artist friends in Toronto, making numerous sketching expeditions throughout Ontario and Quebec. Here, though, Jackson has left the cozy Laurentian villages and their rolling, muddied cart paths for something untamed - the peaks of the Rocky Mountains, which held him in awe. “The obedient in art are always the forgotten,” Jackson once wrote to a friend. “Chop your own path. Get off the car track.”
