Wednesday, January 23, 2013

The amazing yield conundrum

Today's investment climate is unique, if only in one respect: the huge difference between the current yield on cash and on alternative investments.

In a time when cash is yielding almost nothing, investors are faced with alternatives that are much more attractive. Equities, for example, are yielding 700 bps more than cash. Emerging market debt is yielding 650 bps more; high-yield debt almost 580 bps more; BAA corporate bonds 460 bps more; and investment grade corporate debt 320 bps more.

Despite the huge yield advantage to be gained from alternative investments, bank savings deposits—which yield almost nothing—have surged by almost 70% in the past 4 years (13% per year annualized), and are up from $4 trillion to almost $7 trillion.

This can only mean one thing: the market is extremely risk-averse. To pass up equity yields of 7% in favor of cash yields of practically zero, you have to believe that equities are extremely risky, and might well decline at least 6-7% a year for the foreseeable future.

This pessimism is even more pronounced when you consider that on average, the S&P 500 index has increased about 7% per year for the past 60 years. Not only is the earnings yield on the S&P 500 over 7%, the above chart argues that it's expected price appreciation is about 7% a year. The market is passing over a possible equity return of 14% per year in favor of cash that yields nothing.

And it's not just U.S. equities that the market is trying to avoid, it's equity markets the world over. As the chart above shows, the market cap of global equity markets has risen by almost $30 trillion (more than double) even as interest rates on safe-haven assets have plunged and holdings of risk-free assets have soared.

Indeed, one might say that higher equity prices have encouraged a flight to safety. How else to explain that as equity prices return to their pre-recession highs, risk-free yields are approaching historical lows?


Rob said...

Apple ! Help !

Joe said...

Sounds like the perfect description of a liquidity trap, ongoing since 2007/2008 in the US economy.

Gloeschi said...

Hmm, why could it be that those "dumb" investors can't be lured back into this fantastic market? It must be PBS's fault! Those completely unfounded reports don't help rebuild 'con'fidence among the ordinary investor. "Come back in, the water is fine..."
And do it in a leveraged fashion, as Dr. K regularly recommends here.

Joseph Constable said...

Non-seasonally adjusted data from FRED shows from Aug’08 to Dec’12 M2component Savings Deposits did go up $2,694.7 billion. But for the same period M2 non-M1 components Retail Money Funds went down $353.1 billion and Small Time Deposits went down $676.1 billion. So net, we have an increase in savings of $1.665.4 billion. So the operating figure is $1.7 trillion dollars in savings increase.

This added to the $1.1 trillion increase in M1 equals the growth of money supply of $2.8 since just before Lehmann Bros. The money supply stays the same regardless of whether people who have savings accounts start to buy stocks, equity ETFs, and equity mutual funds. The seller gets the cash and it is a deposit somewhere. You would think a good sign might be the ratio of M2 to M1 declines but it has been declining.

The savers can bid up shares because they are eager. The bond holders can rotate out into stocks. Businesses could make more fixed investments. So why don’t they really, Scott’s last paragraph not withstanding? Something is wrong.

roycobden said...

Yeah, the water is fine... Jaws won't bite!

Your retirement investments will be safe.

Trust me!

Benjamin said...

The chart on sovereign yields---do the words "zero bound" come to mind? That is a long secular trend. Very long.

Below zero, yields cannot go.

The Big Q is: Do interest rates go up, or lie dead at zero. They have laid dead at zero for 20 years in Japan.

My guess is that the world's major central banks--China excepted---are too "conservative" (small "c") to take aggressive action to spur growth and som erected inflation.

If central banks are ossified into driving rates lower and lower, then the Japanification of the Western economies is underway.

I like the recent rallies on WS. Good news. Real estate rallying too.

It may be that the Fed's $85 billion a month in QE is paying off.

Of course, I told the Fed to go hard and heavy on QE four years ago....

steve said...

this idea that equities "yield" 7% is totally bogus. an earnings yield is NOT an income yield. forecasting stock returns has always been a lesson in futility and to even suggest that the expected return of equities is 14% by adding earnings yield to long term price appreciation is folly. sounds to me like you're getting toooo optimistic-as many are.

theyenguy said...

The Japanification of the Global Economy is underway. The Age of Deflation commenced on the exhaustion of the US Fed’s QE4, the ECB’s LTROs and OMT, and the BoJ’s, Unlimited Easing, as World Shares, VT, traded lower on January 23, 2012.

Debt deflation, has finally commenced as the Major World Currencies, DBV, and Emerging Market Currencies, CEW, turned lower on January 17, 2014, while the US Dollar, $USD, UUP, traded higher beginning December 14, 2012. The Milton Friedman Free to Choose Floating Currency Regime has failed. Competitive Currency Devaluation is underway.

The World Central Banks’ monetary policies have turned toxic, causing investors to derisk and deleverage out of fiat investments.

Liberalism’s Banker, Free to Choose Floating Currency, Credit, and National Regime will be replaced by Authoritarianism’s Beast, Diktat, Totalitarian Collectivism, and Regionalism Regime.

Investment schemes by Asset Managers such as BlackRock, BLK, and State Street, STT, which supported foreign investing, are now part of the bygone era of prosperity, as the dynamos of corporate profitability and global growth are winding down.

The chart of the S&P, SPY, shows a 0.16% rise for the day, and what may turn out to be an evening star candlestick, denoting a grand finale completion of an Elliott Wave 5 High, which took Large Cap Growth Shares, JKE, up 0.64%, near to its September 14, 2012, high. The currency carry trade Small Cap Pure Value Shares, RZV, traded unchanged, suggesting an end to their rally which began in June 2012, which commenced on the anticipation of the ECB’s OMT.

Leveraged Buyouts, PSP, traded strongly lower, documenting an end to the six month long World Central Banks’ global debt based currency carry trade rally. Liberalism’s final risk on rally was based upon confidence and trust in the most toxic of debt, specifically the Distressed Investments taken in by the US Fed under QE1, FAGIX, Junk Bonds, JNK, Senior Bank Loans, BKLN, all of which traded lower on January 23, 2012. It was Distressed Investments, FAGIX, that underwrote and leveraged the Vice Stocks, VICEX, to a 35% gain over the last two years.

The ability of stocks to leverage up over debt is history. The Age of Leverage has ended, and the Age of Deleveraging has commenced, which can be followed in the combined chart of Closed End Stocks, CSQ, trading ever lower, over Closed End Debt, PFL.

We are no longer in a zero bound investment world. The World Central Banks’ ZIRP Regime is now beginning to fail as the 10 30 US Sovereign Debt Yield Curve, $TNX:$TYX, has been steepening since early December 2012, and is now trading at 0.606. A Steepening Yield Curve, seen in the Steepner ETF, STPP, steepening, means an end to risk free investing. Both International Treasury Bonds, BWX, and Inflation Protected Bonds, TIP, have been fallen lower in value since early December, as bond vigilantes have been calling interest rates higher globally.

An inquiring mind asks, will money market funds, which have traditionally maintained a constant $1.00 dollar value, fail to do so, and start to produce negative returns, oncee interest rates on the 10 Year Interest Rate, ^TNX, rise above 2.0%, and all interest bearing investments, seen in this Finviz Screener, turn lower in value on alarm that the world central banks monetary authority, has not only failed to sustain global growth and corporate profitability, but because of debt deflation, has turned “money good” assets bad.

Pragmatic Investor said...

Steve got it right. You can't add 7% price return to the invisible 7% earnings yield. Can't believe a self claimed pundit would say naive things like that.

Scott Grannis said...

Please note that I said a "possible" return of 14%, not a likely or expected return, and I did not specify any time frame.

marcusbalbus said...

shame on you for adding the
"earnings yeild" to the price appreciation yeild, then getting called out on your pestilient pontification followed by the craven "i said possible" shame on you.