With stock market valuations at very attractive levels and treasuries coming close to zero percent interest the shrewd investor might ask: Why should I even consider fixed income securities when there exist incredible bargains in the stock market? I will try to outline the reasoning beyond going into the fixed income sector in this short essay.
First of all: We have another bubble! As always before the bubble bursts most investors are not aware that one even exists – but that will inevitably change in the aftermath of this recession. The Fed printed money for a long time now: When Alan Greenspan became chairman he was pursuing a far different path than his predecessor Paul Volcker whose foremost concern was to stabilize the dollar. Greenspan did quite the opposite: He stimulated the economy by doing a loose monetary policy and consequently allowed the dollar to depreciate. He left Bernanke a difficult heritage as former is now squeezed between two threads: Keeping the economy liquid – without to devalue the dollar to such an extent that we get a hyperinflation and subsequent a run out of the currency into gold and other non productive investments.
The bubble is in treasury bonds! Investors are paying a high price for the cheery consensus that there is a safe heaven in treasuries. There are two ways for coming out of this recession:
1) The Fed policy stimulates the economy. Then the enlarged money supply will inevitably lead to rising prices and rampant inflation to establish a new balance between goods and money. In this scenario interest rates will sooner or later have to rise as investors will not finance the US for negative returns.
2) The Fed policy will not succeed and we get the “ Japan experience” – namely a depression. This would mean that interest rates will play no role anymore as “people will not consume today because consuming tomorrow will be cheaper.” Then our corporations will be plagued with overcapacity an our economy will lie in shambles – eventually for a long time.
According to Warren Buffett the first scenario is what he expects – he never mentions the deflationary scenario – for good reasons: A deflation starts into the people’s minds and it is therefore in his best interest to project the opposite urging the people to consume. However on this crossroads it is in my opinion impossible to predict what will happen, naturally one will try to be prepared for both scenarios.
Here’s why a hundred percent stock portfolio is likely not the best capital allocation in the current situation and how we can excel:
Stocks have a great long term outlook with prices being currently in the basement. However over the next three years paid out dividends will be rather low as companies are preserving their liquidity in these uncertain times. Consequently the investor will not receive high income payments for as long as uncertainty remains high.
Reversely in the Bond market corporations are forced to pay high coupons. Adding to these coupons the oftentimes substantial amounts of discount to par value an investor will currently get double digit yields without having to forego adequate standards of safety – as described by Graham&Dodd in Security Analysis. In Part 2 I will shortly describe these standards and then apply them to a vivid example!
Sascha Seiler
First of all: We have another bubble! As always before the bubble bursts most investors are not aware that one even exists – but that will inevitably change in the aftermath of this recession. The Fed printed money for a long time now: When Alan Greenspan became chairman he was pursuing a far different path than his predecessor Paul Volcker whose foremost concern was to stabilize the dollar. Greenspan did quite the opposite: He stimulated the economy by doing a loose monetary policy and consequently allowed the dollar to depreciate. He left Bernanke a difficult heritage as former is now squeezed between two threads: Keeping the economy liquid – without to devalue the dollar to such an extent that we get a hyperinflation and subsequent a run out of the currency into gold and other non productive investments.
The bubble is in treasury bonds! Investors are paying a high price for the cheery consensus that there is a safe heaven in treasuries. There are two ways for coming out of this recession:
1) The Fed policy stimulates the economy. Then the enlarged money supply will inevitably lead to rising prices and rampant inflation to establish a new balance between goods and money. In this scenario interest rates will sooner or later have to rise as investors will not finance the US for negative returns.
2) The Fed policy will not succeed and we get the “ Japan experience” – namely a depression. This would mean that interest rates will play no role anymore as “people will not consume today because consuming tomorrow will be cheaper.” Then our corporations will be plagued with overcapacity an our economy will lie in shambles – eventually for a long time.
According to Warren Buffett the first scenario is what he expects – he never mentions the deflationary scenario – for good reasons: A deflation starts into the people’s minds and it is therefore in his best interest to project the opposite urging the people to consume. However on this crossroads it is in my opinion impossible to predict what will happen, naturally one will try to be prepared for both scenarios.
Here’s why a hundred percent stock portfolio is likely not the best capital allocation in the current situation and how we can excel:
Stocks have a great long term outlook with prices being currently in the basement. However over the next three years paid out dividends will be rather low as companies are preserving their liquidity in these uncertain times. Consequently the investor will not receive high income payments for as long as uncertainty remains high.
Reversely in the Bond market corporations are forced to pay high coupons. Adding to these coupons the oftentimes substantial amounts of discount to par value an investor will currently get double digit yields without having to forego adequate standards of safety – as described by Graham&Dodd in Security Analysis. In Part 2 I will shortly describe these standards and then apply them to a vivid example!
Sascha Seiler
