Remember talk about the lost decade in stocks? With the market's summer rally, up nearly 13% since the beginning of June, there's a new candidate for serving up investors with a lost decade, and that's cash. For the ten years ending August 31, 2012, the average annual total return on the S&P 500 has been 6.51%, running circles around cash (90 day Treasury bills), checking in at just 1.67%.
That's right, you could have done well for the last 10 years, with each $100 compounding to $187, simply by becoming a Rip Van Winkle. Those gains would have been yours by failing to react to the Iraq invasion, the Katrina disaster, the housing and subprime meltdown, the AIG bailout, the Lehman collapse, the emergence of China as a superpower, the Euro sovereign debt crisis, and a 50% drop in the Dow between October, 2007 and March, 2009.
There's no question that the stock market is overbought: Following a 116% gain off the market bottom of March, 2009, and a 22.5% year over year gain to date, a correction is to be expected and should be considered healthy.
Further headwinds to the market are obvious. The long-term solution to bloated budgets among the European economies has yet to be found. On this side of the pond, economists fret over the effects of the fiscal cliff: the tax hikes and spending cuts to occur in 2013 absent legislative relief. China, now the globe's second largest economy, is reporting a significant reduction in exports. Corporate earnings growth is expected to tail off as the world economy slows and earnings comparisons versus last year are tougher.
Central banks around the world are determined to do what it takes, including injecting massive amounts of liquidity into the system, to fend off a debt crisis in the Eurozone and reduce unemployment here. The monetary stimulus is reflected in record low interest rates, making equities still look cheap. Indeed, rarely has the yield on the ten year Treasury, now at 1.86%, been less than the dividend yield on stocks, now at 2.15% on the S&P 500. That equity yield advantage bodes well for stocks; historically, dividends have grown 5% annually.
Investors have flocked to income alternatives, but it's not clear that they will fare as well as equities, as these yield plays have now become quite expensive. Corporate bonds are trading with an average yield of just 2.88%, down from 3.6% a year ago. Junk bond yields are at record lows, below 7%. REITS, a favorite yield vehicle, have rarely been so expensive and yielded so little. For example, Barron's reports that Vanguard's REIT fund (Vanguard Real Estate Investment Trust (VNQ)) yields just 3% and trades at 18 times earnings.
While the fiscal cliff is cited as a major market hurdle, it actually may prove a long term salve. Europe proves, if it wasn't known already, that deficits do matter; policy changes designed to reduce deficits and therefore the risk of skyrocketing inflation and interest rates down the road should be beneficial.
Although the unemployment rate remains way too high, housing is starting to stabilize. With the 30 year mortgage rate down to an historic low of 3.55%, home prices are remarkably affordable. This is likely to remain so for some time as the Federal Reserve has committed to buy $40 billion a month of mortgage backed bonds for an indeterminate time in an effort to reduce unemployment.
The all-important auto industry is showing signs of life, too, with recent sales at an annual rate of nearly 14.5 million/year, the best since 2009's cash for clunkers surge.
Closed End Funds: Buying Great Portfolios at a Discount
No question, although the long term outlook is fine, with stock prices up so dramatically, the low hanging fruit is gone. Investors will have to work harder to find quality marked down.
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By David G. Dietze, JD, CFA, CFP™
Founder, President and Chief Investment Strategist
Point View Wealth Management, Inc.
September 17, 2012