Stocks, Bonds and Five Decade Anomaly Returns
Adrian Ash, October 22nd, 2009
Page 1
Stocks now pay way less than bonds once again, but neither pay much...
BLINK and you missed it. US equities offered a greater yield on investment than did US Treasury bonds for less than five months...
And from the day this oddity struck, 18 Nov. 2008, the S&P still had another one-fifth to fall.
"When this inversion occurred, my two older partners assured me it was an anomaly," wrote the late Peter Bernstein in Nov. 2008.
The inversion Bernstein referred to had occurred five decades earlier...back when the dividend yield offered by US equities slipped below the yield offered by Treasury bonds for only the second time in history.
Wake up there at the back! This might be important. Because in 1958, savings were offered a lower return as risk capital in US business than as a loan to Uncle Sam. Which was absurd. The only other time this had happened - and only then for six months - was right at the top of the 1929 stock bubble.
And you can see how the Great Crash fixed that anomaly on our chart above.
"The markets would soon be set to rights," Bernstein's senior partners agreed just as Elvis was getting his Fort Chaffee crew-cut, "with dividends once again yielding more than bonds. That was the relationship ordained by Heaven, after all, because stocks were riskier than bonds and should have the higher yield."
High risk equals higher return, right? Risk-free bonds should pay less per year...just as they had done for as long as anyone dared to remember. US equities, on Robert Shiller's data at least, offered an average yield 1.8% above Treasuries between 1871 and 1958.
How's that for a law of the universe?
But what Nature ordains and how investors behave are two different things, as early bears too often find to their cost. London's Tony Dye moved $10 billion of his clients' money out of stocks into bonds in 1995. Come March 2000, he was forced to step down as chief investment officer at PDFM, just as his call came good. (Dye then called the top of the real-estate bubble...in 2004.) And what seemed aberrant to old hands in the mid-20th century has since become hard financial fact. Stocks offered to yield 3.7% less than bonds in the fifty years to last November, even though Uncle Sam was obliged to repay you in full at redemption, while no one was (or is) obliged to buy your stock at the price you (or anyone before you) paid.
Forget risk, just get used to it. This iron law even got a name - the Fed Funds Model, based on the idea that Fed officials in the mid-90s were actively targeting stock prices by working long bond yields - and became so entrenched during the five decades to last Christmas, you could hang your jacket on the bullishness sparked by any hint of reversion.
