As I was reading through Annaly Capital Management's first-quarter market commentary, I was struck by a table at the end. Specifically, three data points jumped out at me:
|10-Year U.S. Treasuries||3.47%||3.83%||(9.3%)|
Source: Annaly Capital Management.
This doesn't seem to make a whole lot of sense. Looking at the data, I feel a bit like the infamous double rainbow guy, anxiously wondering "What does this mean?"
Double rainbow gains
Because bond prices move inversely with yields, the drop in Treasury rates implies a rise in bond prices, so all three asset classes in the table were rising over the past year.
A rising stock market is generally interpreted to mean that the economy is improving -- or at least investors think that the economy is improving. It could also benefit from anticipated inflation as investors look ahead to nominally higher profits.
Treasuries are often a refuge when investors are uncomfortable about the future. Since they're guaranteed by the U.S. government, there's a strong sense that the principal is safe. Because 10-year Treasuries carry a fixed interest rate, though, they also generally perform better when expectations call for lower inflation.
Finally, gold is seen primarily as a safe haven. When protection from economic uncertainty, inflation, and larger currency concerns is sought, gold is a likely destination.
Try to fit those pieces together and you might come to the conclusion that this is a pretty odd situation. And what does it mean? Well, I found myself assuming that it signaled some truly significant event was on its way -- aliens landing, the Mayans being proven right about 2012, Vin Diesel winning an Oscar -- you know, really wacky stuff.
It's not unusual
I have no idea how common double rainbows are, but seeing year-over-year gains in all three of these asset classes isn't as uncommon as you might guess. Over the past 40 years, it's happened nine times -- which means this double rainbow pops up more than 20% of the time, or roughly once every five years.
Maybe the explanation, then, is somewhat tamer than what I assumed earlier. Maybe this is simply a sign that there is too much money sloshing around in the economy, and it's all charging into investable assets and pushing prices of everything up. If that's the case, it seems it's a clear sign that inflation is on the way.
That sure seems like a plausible story, and if I ran with it I'm sure there would be plenty of people agreeing with me. Unfortunately, the data don't back that up.
In 1971, gold rose 14%, 10-year Treasury yields fell 16%, and stocks were up 36% and the consumer price index increased at a rate of 8.4% per year over the next decade (ouch!). However, in 1993 -- when gold was up 5%, 10-year Treasury yields down 16%, and stocks up 10% -- the double rainbow gains led to a decade of 2.4% annual inflation. And the rest of the data fall somewhere in between.
For the last time, what does it mean!?!?
If you're scratching your head at this point, then we're on the same page. It could be that what's behind this is completely banal: Investors are confused as heck and have no idea what the best place is for their money. And if that's true then, (gasp!) the simultaneous gains for gold, stocks, and Treasuries may "mean" nothing at all.
This last explanation is by far my favorite. Investing is a pursuit particularly prone to be being thrown off by cognitive biases. One of those biases is called the "clustering illusion," and it deals with humans' love of patterns and our predilection for finding non-existent meaning in random data.
Particularly now that so much data is available for investors to sift through, I think many investors go overboard trying to analyze it all and make it say something about where the market is headed. In this process, random patterns suddenly become meaningful, statistical concepts like reversion to the mean get twisted worse than a pretzel, and investors assume that they've got data-backed proof of what the market is going to do.
It can actually all sound very erudite until you're Long Term Capital Management, Amaranth, Lehman Brothers, AIG, or some other cautionary tale.
Do this, not that
That's not to say that all the data available for the stock market and economy is useless. It's not. But since even the smartest folks out there seem unable to cull that data into something consistently useful, I prefer to take an easier path.
Instead of trying to read the tea leaves in an attempt to predict the market, I prefer looking at stocks for what they are: ownership interests in businesses. As such, my investing is primarily concerned with finding well-run, enduring companies that I can buy at a good price -- and I prefer that businesses consistently pay me with dividends.
I recently highlighted Telefonica
These are the types of investments I relish because you don't need to do any statistical analysis to figure that people all over the world will be drinking Coke a few decades from now. And you don't need to cull a pattern from a chart to determine that -- though recessions may slow sales for a bit -- consumers are going to keep buying refrigerators and washers and dryers from Whirlpool.
But that's just a start. For six more investment ideas that have nothing to do with abstract data and everything to do with strong business cases, check out "6 Stocks David and Tom Gardner Think You Should Be Watching." It's a special report from the co-founders of The Motley Fool, and you can claim a copy absolutely free.