Bonds: Out. Stocks: Out. What's Left?

In his most recent report, respected asset allocation consultant Andrew Smithers concludes that basically all bonds are overpriced (see table below), whether they be guvvies (government bonds), corporates, or inflation-protected. That's pretty unfortunate, especially when you consider that stocks are also broadly overvalued. So what's left for an investor?

Investment

Yield

10-year Treasury bond

3.27%

10-year Treasury Inflation-Protected Securities (TIPS)

1.08% [real]

Investment-grade corporate bonds*

4.92%

High yield corporate bonds*

9.79%

Treasury bond data as of Dec. 1, 2009. Corporate bond date as of Nov. 30, 2009.
*Average redemption yield.
Source: Bloomberg

Cash is the worst asset -- except for all the others ...
Both stocks and bonds currently promise poor returns because investors are bidding prices up, desperate to put their cash to work anywhere there's a hope of earning something greater than zero. But whether these assets will end up working for or against them remains to be seen. Cash has some interesting attributes: It presents no risk of capital loss, and it leaves investors with flexibility.

Investors don't need to choose between buying risky assets immediately or holding cash for the next 10 years. When the former are overvalued, one can simply hold cash until prices become more attractive. In my opinion, we certainly won't have to wait 10 years for that to happen.

Stockpicking is an alternative
One alternative, for investors with the necessary time and the expertise, is buying carefully selected, well-priced stocks (yes, there are still some out there). The following shares, for example, are in the top 10% of the S&P 500 in terms of their forward earnings yield. (They are not recommendations -- please do your own due diligence.)

Company

Forward Earnings Yield

Long-Term Earnings Growth Estimate

ConocoPhillips (NYSE: COP  )

11.2%

7%

UnitedHealth Group (NYSE: UNH  )

10.6%

12.5%

Eli Lilly (NYSE: LLY  )

12%

5.3%

Pfizer (NYSE: PFE  )

12.3%

(0.3%)

Loews (NYSE: L  )

11%

-

Constellation Brands (NYSE: STZ  )

9.7%

9%

AFLAC (NYSE: AFL  )

11.2%

14.3%

Source: Capital IQ, a division of Standard & Poor's and author's calculations, based on data from same.

The game plan
Unless you're investing in individually selected stocks, rather than through index funds, I recommend being underweight the broad U.S. stock market and bonds. Holding cash doesn't make sense unless none of the alternatives do. By and large, that's  the case right now. When -- not "if" -- asset prices become more consistent with economic reality, that cash will come in mighty handy.

Be wary of pundits who are goading investors into chasing returns. Here are three more reasons you're being set up to fail.

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Fool contributor Alex Dumortier, CFA has no beneficial interest in any of the companies mentioned in this article. AFLAC and UnitedHealth Group are Motley Fool Stock Advisor recommendations. Pfizer and UnitedHealth are Motley Fool Inside Value picks. The Fool owns shares of UnitedHealth. Try any of our Foolish newsletter services free for 30 days. The Fool has a disclosure policy.


Read/Post Comments (19) | Recommend This Article (37)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 01, 2009, at 5:30 PM, shockmeee wrote:

    No remarks about gold and silver? That seems like a major oversight since the metals are vastly out-performing all other investment classes.

  • Report this Comment On December 01, 2009, at 5:36 PM, bretco wrote:

    "No risk of capital loss ? "

    Ever hear of something called inflation ?

  • Report this Comment On December 01, 2009, at 5:42 PM, Howard1ii wrote:

    This only confirms that consistent dividend paying stocks have to be part of any plan

  • Report this Comment On December 01, 2009, at 5:56 PM, CatTrades wrote:

    how 'bout a weak dollar ?

  • Report this Comment On December 01, 2009, at 6:03 PM, Workn2Hunt wrote:

    This poser is why I don't need no stinkin' broker to invest my money. The dollar now will be worth a fraction in 10 years.

  • Report this Comment On December 01, 2009, at 6:27 PM, TMFAleph1 wrote:

    @bretco,

    You're quite right. However, I'm reasoning on the basis of a 6-24 month time horizon here, over which period period your loss of purchasing power is likely to be negligible in absolute terms and relative to the potential price loss on risk assets.

    Thanks for your interest,

    Alex Dumortier

  • Report this Comment On December 01, 2009, at 6:30 PM, judydennistoby wrote:

    I'm on the verge of retirement, disabled and don't have time for this. I lost a fortune last year but was gutsy and started reinvesting in December 2008. Have gain a modest amount back but my time is so limited now!! What do I do with a "chunk of change" to have an income stream and some growth to in this soon-to-be socialist society called America?? Would sincerely appreciate any suggestions--

  • Report this Comment On December 01, 2009, at 6:35 PM, TMFAleph1 wrote:

    judydennistoby,

    While I cannot offer specific financial advice, one area you can explore is high-quality, dividend stocks.

    Best,

    Alex Dumortier

  • Report this Comment On December 01, 2009, at 6:48 PM, sailrmac wrote:

    Well since everyone seems to think the dollar is going to continue it's decline, 4 out of 4 so far posted about inflation or gold, that's a pretty good signal.

  • Report this Comment On December 01, 2009, at 7:05 PM, OPTIONNUT wrote:

    OK Fools,

    Does not APPL make your stockpicking list with a much greater growth potential even at 200 bucks a share than your picks. Have you Fools lost your MOJO?

    Where are you guys coming from?

    I want my money back!

    G

  • Report this Comment On December 01, 2009, at 7:07 PM, MajStrom wrote:

    10 to 20% should be in gold or silver. Have the metals, not stock or storage.

  • Report this Comment On December 02, 2009, at 6:03 AM, extremist wrote:

    This is a rare time when everybody is screaming inflation and weak dollar, yet everybody and his uncle are calling a top in gold. Telling which way it's going to go is beyond my severely weakened psychic powers.

  • Report this Comment On December 02, 2009, at 7:10 AM, SnapDave wrote:

    It’s about time one of you Fools had the cajones to suggest cash. Put some in a foreign currency if you understandably have concerns about USD.

  • Report this Comment On December 02, 2009, at 12:03 PM, ET69 wrote:

    Face it ..Capitalism is a crap shoot! Any hot tips on hot horses out there? Happy Holidays!

  • Report this Comment On December 02, 2009, at 9:48 PM, TMFAleph1 wrote:

    @scherniak,

    Thanks for your interest. One could perhaps consider that "5% on investment-grade corporates and 9% on high-yields is quite good" in a normal economic environment. In the current environment, those yields look something less than "quite good" to me.

    Best,

    Alex Dumortier

  • Report this Comment On December 03, 2009, at 11:31 AM, sharktrade wrote:

    You have to work Guy !

  • Report this Comment On December 03, 2009, at 1:20 PM, DenverAce wrote:

    Hot off the press: Bernanke Sees No ‘Extreme Misvaluations’ in U.S.

    Ben Bernanke said today (December 3) that he sees no sign of “extreme misvaluations” of asset prices in the United States.

    “We do not see at this point any extreme misvaluations of assets in the United States,” Bernanke told the Senate Banking Committee today during a hearing on his nomination to a second term as chairman. “It is inherently very difficult to know if asset prices are appropriate or correctly valued.”

  • Report this Comment On December 04, 2009, at 8:09 PM, PhillyFrog wrote:

    What about commodities?

  • Report this Comment On December 07, 2009, at 1:10 AM, globalsailor wrote:

    The risk in bonds is inflation. The risk in stocks is the junkiness of the American economy. I'm going foreign stocks, but short American bonds might be okay. Try FXA for fixed income. It's tied to an Australian dollar money market. They just raised rates.

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