Mr. Market is a stand up kind of guy, and I admire that about him. Unfortunately, stand up kind of guy is just part of his character for he has another side to him. Mr. Market is a very excitable guy. He can swing wildly from euphoric to deep down end of the earth depressing. He is completely emotional at times and this overwhelms his ability to rationalize with him. Who can blame him?
I mean he is blasted by CNBC with their self proclaimed "All-Stars" who see no ethical or morale reason to not try and stoke fear in investors. They hire the likes of Jeff Cox, a former newspaper man from Philly, and he will constantly point out the negatives (Like writing about "death cross" patterns or as he did today. He comes out and says that the markets are still too complacent and they will fall much further) of the market. They schedule their guests like Meredith Whitney to speak gloom and doom without have a very good track record (Yes, she got the Citigroup dividend cut right when no one else did, but pretty much everything else out of her mouth has cost investors.). The use nice adjectives like "plunge" and breaking news flashes like "Bank of America in peril". Reckless is the word that comes to mind when thinking about CNBC's tabloid style of news reporting and immoral is the word to think about if it is all done for viewership (As Sue of CNBC noon show thanked God that everyone was watching CNBC these days.). CNBC in my opinion is a likely reason why Mr. Market is getting very emotional these days. He is making poor decision based upon his emotions and lack of rationale.
Mr. Market seems to be selling even good quality blue chip multi-national stocks at extremely low valuations relative to their historical valuation ratios. These stocks have just recently reported good second quarter earnings. He is taking these dollars and running at lightening fast speed into the perceived safety of U.S. Treasury bonds despite the recent down grade in credit quality to AA+ from AAA and driving the yields on these securities to around 2.10% on the 10-year T-Bond. This in my opinion puts the 10-year T-bonds yield in a negative real return environment and though it will most likely not have a credit default the purchasing power of the principal and future coupon payments is likely to be inflated away and diminished.
Mr. Market seems to be trading away long dated assets/enterprises like Coca-Cola, Pepsi, Wal-Mart, GE, Kraft, ConocoPhilips, Exxon, Chevron, Clorox, P&G, J&J, Berkshire Hathaway, Union Pacific, MasterCard, American Express, JP Morgan, Citibank, Wells Fargo, Bank of America to name just a few of his stocks for government bonds. Mr. Market has most likely I guess been listening to the hacks and tabloid reporting of CNBC and allowing it to depress him emotionally and numb his sense of rationality.
Mr. Market, It is pretty simply you have a few major asset classes to put you money. You can put it into 10-year Treasury bonds, the S&P 500 or everyone's current favorite gold. Let me layout you opportunity set for your rationale consideration:
The yield on the 10-year Treasury Bond is around 2.10% before tax. Thus, Mr. market if you are in the 35% tax bracket the after tax yield is 1.37% (rounding up). This return seems pretty poor considering inflation has average over 2.4% annually for the last 20-years. Thus, if we get historical inflation then you would only suffer a 1.03% loss in purchasing power annually for the next 10-years.
So Mr. Market, the "real yield" on 10-year Treasury Bonds is - 1.03% and the nominal is 1.37% after tax. (I like to think of this as 1 inch hurdles that can be stepped over rather than having to run and jump.)
The S&P 500 has a forward P/E of around 11.9. If for simplicity sake, we forget the debt of these corporations because we are also forgetting the historically high levels of cash these companies have on their balance sheet, we can get a pretty simple earnings yield calculation by dividing 1 by the P/E of the S&P. So, 1 divided by 11.9 gives us an earnings yield of around 8.04%. In my opinion, this is pretty good. If you consider that many of the stocks listed previously have market like P/E multiples, you might also want to consider many of them have dividend yields of around 3% to 4% annually (Just a side note is that many of them have also raised their dividends recently and have consistent histories of doing so in the past.)
So Mr. Market, the S&P has an earnings yield of around 8.04%. The yield is also its after tax yield for earnings are after tax, and has a "real yield" of around 5.64% if you subtract the historical rate of inflation. The dividends paid out are taxed at a maximum of 20%. So if we say they have a dividend yield of say 1.9% for the S&P, the after tax dividend yield would be 1.52%. So Mr. Market, it seems that between stocks and the 10-year government bond the yields favor stocks from both an earnings yield perspective and a dividend perspective.
Gold. Nice. It is pretty. It is just very difficult to value it for it does not have any income associated with it. In fact, it costs you money for it needs to be stored (i.e Buy a safe, rent a safety deposit box, or have a custodian hold it for you. I guess you could hide it in a coffee can but coffee cans cost money too!!!. Warren Buffett recently talked about the value of gold, and basically said the following. If you gather up all of the gold in the world and melted it into one big cube that cube would be something like 65 years by 65 yards. It would be huge and shiny and not much else. It could provide you shade, but it won't keep you warm or feed you. You could as he said run over to it from time to time and fondle it. It just more likely to sit and stare at you than do anything. Now, what is it worth? Hard to tell but according to Buffett based upon gold prices at the time of his annual meeting (I believe in May,2011). Buffett said you could purchase ALL of the farm land in America, 3 or 4 Exxon Mobil and have a Trillion or so dollars leftover for walking around change. Mr. Market that farm land will feed you, that oil will give you electricity for heat, a/c,, transportation and cash maybe you can buy some gold from someone of light it on fire to keep you warm. I know you would say the gold would allow me to buy those things and I would get all of yours for some of my shiny and pretty metal. It depends. If it was freezing cold and you need heat to avoid freezing to death the gold will do nothing directly for you and what is the value of a gallon of oil at that point? Is it a 65 yards by 65 yards cube of gold? How much oil would it take for me to move that big cube back to my house?
Gold is the extreme play when people question monetary policy. If cash has no yield and gold has no yield then the opportunity cost for holding it is perceived to be none. I believe this was called the "Gibson Paradox". You can however over pay, and have opportunity costs. Buffett said he would prefer good quality companies that pay a dividend over gold. I believe Mr. Market you can see his portfolio on GuruFocus.com to get a buy list.
Clearly, stocks have an advantage to its prime competitor 10-year treasury bonds and though short term Mr. Market the stocks of the S&P 500 will fluctuate over time they will likely serve as a better store for your wealth than those bonds. Mr. Market what seems safe is generally risky because it is in demand and the price determines it. What seems risky is often discounted and offer better risk and reward.
What is it going to be? I just want to say that you have now been officially warned and it is every man for himself. SO no saying later that I took advantage of you.
Happy investing to all, and please always do your own home work in investing.
Disclaimer: I am long all of the stocks in this letter and all can change any time and are not recommendations for you to buy.