Good news, folks: Stocks are now outperforming junk bonds by the widest margin in a decade and they remain at rock-bottom valuations compared with bonds. Don't fight the Fed. Get your stocks while they're cheap!
Ah, the familiar refrain of stockbrokers and pundits pandering to speculative enthusiasm. Dear reader, let me warn you against playing the frog to the professional investors' ox, for the ox could very well end up bursting here.
Here's the kind of numbers these stock sirens will use to lure you into the high waters of this market:
SPDR S&P 500 ETF (NYSE: SPY )
|Performance since the end of August*||14.4%||5.8%|
|Average Yield (For stocks: earnings yield)*||7.2%||8.5%|
*At Nov. 12. Source: Yahoo! Finance and State Street Global Advisors.
The fallacy of cheap stocks
According to Bloomberg, the gap between the earnings yield on the S&P 500 and the yield on junk debt is the narrowest it has been since Barclays began tracking its junk bond index in 1991. Based on this and similar observations regarding stock dividend yields and Treasury yields, many investors are jumping to the conclusion that stocks must be a buy. Tragically, there are two irreparable problems with that notion:
- The spread between stocks' earnings or dividend yields and bond yields is not a good valuation indicator for stocks.
- At best, this indicator might show that stocks are cheap relative to bonds. That stocks are cheap compared with bonds is true, but people appear to be confusing that notion with the proposition that stocks are to be bought right now. Of course, this is exactly the muddle that Federal Reserve Chairman Ben Bernanke wishes to foster.
General Bernanke's doomed campaign
I first warned investors about a "junk" rally in stocks back in August 2009. That rally came to a halt this year, but with Mr. Bernanke's bubble-building bond buys, it's off to the races again: "Don't fight the Fed!" is the rallying cry of professional investors. I'd rather stay neutral in this battle; I certainly won't follow General Bernanke into a certain rout.
Some smart choices today
Whatever the conditions, there are always rational options. High-quality stocks are legitimately undervalued -- think blue chips such as ExxonMobil (NYSE: XOM ) , General Electric (NYSE: GE ) , or Coca-Cola (NYSE: KO ) . Furthermore, despite what General Bernanke wants everyone to believe, cash isn't an irrational choice right now because it's the mother of opportunity when markets correct. Buyer beware.
Forget high-yield bonds. The Motley Fool's top analysts have identified 13 High-Yielding Stocks to Buy Today.