Fixed-Income Bubble: Should Investors Just Buy Stocks?
Daniel Moser submits:
Discussions about a bond market bubble have been all the rage as of late. Historically low yields are frequently cited as evidence that the bond markets are in a bubble. Another often cited argument, specific to government bonds, is that the supply of bonds keeps growing and eventually investors will reject purchasing this paper at such low yields – which will force yields higher and investors who previously bought into the market will get burned. A third argument is that inflation will likely increase over the coming years which will, in terms of real dollars, lead to losses for bond investors. Most people in this camp tend to argue that this bond bubble will end in tears for investors who piled in during the last stages of this bubble.While these arguments might represent a compelling case to avoid fixed income investments (particularly government bonds), there is another group of investors, bankers, and asset managers who extend the argument to suggest that stocks are the superior investment because bonds are, in fact, in a bubble with historically low yields. Typically this argument utilizes a tool referred to as the “Fed Model” which essentially argues that when the earnings yield on equities is greater than the yield on long term bonds, then investors should shift more of their assets into stocks. Based on my back of the envelop calculations, the current S&P 500 earnings yield is approximately 7% – easily above the yields on a 10 year government bond under 3%. Thus, stocks must be cheap. Not so fast! Wait just a minute...Complete Story »