IS WARREN BUFFETT CORRECT ON THIS ONE?
by David Rosenberg, Chief Market Economist, Gluskin Sheff
Hey, everyone is entitled to his or her opinions, especially oracles:
“They’re making a mistake, the ones that are buying the bonds ... It’s quite clear that stocks are cheaper than bonds. I can’t imagine anybody having bonds in their portfolio when they can own equities, a diversified group of equities. But people do because they lack of confidence. But that’s what makes for the attractive prices. If they had their confidence back, they wouldn’t be selling at these prices. And believe me, it will come back over time.”
That’s quite a statement considering what bonds, even at ultra-low yield levels, have managed to generate in terms of total returns this year compared to the equity market. It’s not even close, with all deference to the recent snapback in the stock market.
More fundamentally, there is a critical difference between something that is government guaranteed and comes due in 10 years versus something that has downside capital price risks and never comes due (ask former Nortel investors about that one).
So let’s examine a high yielding stock in the S&P 500 — say, for example, Pfizer. This is a classic “bond in drag” — it actually started the year with the same yield as the 10-year Treasury note. Pfizer started the year at $19, went to $14, and now in this flashy rally has gone to $17. It’s down around 10% for the year. Merck has a similar yield and has experienced no price appreciation at all. But the 10-year bond started the year at 3.85%, a yield that at the time most of these perma equity bulls did not want to touch, and now the yield is down to 2.45% and the price has increased 10% so far in 2010. Not a bad deal, eh?
If the truth be told, the last time we had the 10-year note yield at today’s level the S&P 500 was trading near 1,060. In fact, at the 666 lows, the 10-year note yield was also exactly where it is today. The bond market sniffs something — more often than not. It rallies from interim highs, as we have seen since April, and foreshadowed something that was not particularly friendly to risk assets months down the road ... July 2007 and February 2000 seem to come to mind. Patience and discipline and continued recital of Kipling’s “If”.
Then again, this rally has all occurred in a depreciating U.S. dollar environment. Gold is the hardest currency of all and in bullion terms, there has been no bounce-back at all.
This note is an excerpt from today's Breakfast with Dave. A free and worthwhile registration is required.
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