Don't March With General Bernanke

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!

Aesop revisited
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:

 

Number

Stocks

SPDR S&P 500 ETF (NYSE: SPY  )

High-Yield Bonds
SPDR Barclays Capital High Yield Bond ETF (NYSE: JNK  )

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:

  1. The spread between stocks' earnings or dividend yields and bond yields is not a good valuation indicator for stocks.
  2. 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.

Fool contributor Alex Dumortier has no beneficial interest in any of the stocks mentioned in this article. Coca-Cola is a Motley Fool Inside Value pick. Coca-Cola is a Motley Fool Income Investor pick. The Fool owns shares of Coca-Cola and ExxonMobil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (4) | Recommend This Article (5)

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 November 16, 2010, at 6:26 PM, langco1 wrote:

    once obama is removed from office over his failure to run the country the rest of his picks like bernanke and geithner will hit the dumpster...

  • Report this Comment On November 17, 2010, at 5:04 AM, ryanalexanderson wrote:

    > once obama is removed from office over his failure to run the country the rest of his picks like bernanke and geithner will hit the dumpster...

    Uh...might want to check your history book on who "picked" Ben Bernanke. In 2006.

    Better yet, try to avoid being distracted by partisan politics. They're an amusing sideshow, but not the cause of all this.

  • Report this Comment On November 17, 2010, at 12:21 PM, VirginiaPacific wrote:

    "I first warned investors about a "junk" rally in stocks back in August 2009. That rally came to a halt this year..."

    Although I have agreed with this thesis for a long time, lower quality and smaller cap stocks have continued to outperform the market since August 2009. It seems like you're trying to obscure your actual performance.

  • Report this Comment On November 17, 2010, at 12:59 PM, TMFAleph1 wrote:

    @VirginiaPacific,

    Not trying to hide my actual performance. When I wrote that the rally came to an end, I should have been more careful: I was actually referring to the broad market rally, not the outperformance of low-quality stocks specifically. I did not have in mind touting/ trumping up the accuracy of my August 2009 warning when I wrote this.

    Alex Dumortier

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