Yields: The Dominant Theme for 2011
Source: Clif Droke (12/6/10)
"Momentum bull market in gold has been driven by something more than fear."
What will be the driving forces behind this bull market? Aside from the fact that the 4-year cycle has bottomed and the 6-year cycle is still in its "hard up" phase until next September, the stock market has some notable positives in its favor from an intermediate-term (6-9 month) standpoint. Hedge funds and institutional interests have spent considerable funds pushing this market higher in the last 18 months since the bottom of the last bear market. The public, by contrast, has been conspicuously absent from the market this whole time and have instead preferred the safety of Treasuries against the higher risk (and higher reward) of stocks. The professional element needs someone to see to and will be looking to unload at the top of the next cycle next summer. That someone would of course be the small retail trader.
It would be surprising if the public (at least as many of them as can be persuaded) weren't enticed back into the stock market in 2011. The public has been stuck in neutral for almost two years in low-yielding money market and Treasury funds. They're earning next to nothing on their money and are growing tired of it. They're seeing the attractive yields being offered on many stocks and analysts and stock promoters have been pushing the yield story for some time. Investors are starting to emerge from the bunkers in the pursuit of these attractive yields.
Back in October, Barron's Tom Sullivan observed that with interest rates currently near multi-decade lows, investors can do nearly as well keeping their money under the mattresses as opposed to money funds. Not long ago a 30-day taxable money market fund offered an average yield of just 0.04%. "Little wonder," wrote, "Sullivan, "investors on balance have pulled $1 trillion out of them since the beginning of 2009." This was just one of a growing number of articles appearing in the financial press which highlight the paucity of income potential in money market funds. At the same time, writers and analysts are pushing the idea of buying stocks with attractive yields as an alternative to low-yielding money funds.
To take just one example, Businessweek:pointed out that investors put more money in the S&P 500's dividend exchange-traded fund, the SPDR S&P Dividend, in September than ever before, while the Dow Jones Industrial Average's dividend ETF, the iShares DJ Select Dividend Index, had its best month since January 2005.
Barron's ran as the cover story this week a look at yield investing, observing that with yields near historic lows, "Treasuries simply aren't cutting it as the mainstays of income portfolios, and rates on bank CDs are pitiful." As the first big wave of retiring Baby Boomers begins in 2011, the search for higher yields will increase. Stocks will curry favor among yield hungry investors due to the fact that dividend yields on investment quality stocks are higher now than they've been in years.
Consider the following observation made in the latest issue of Businessweek: "Willing to give up the prospect of faster earnings growth for the current income offered by dividends, investors are driving the biggest rally for telephone stocks in seven years." The article goes on to say that "Dividend yields of phone companies from Royal KPN to AT&T pay more than their own bonds, leading some money managers to favor equities over fixed-income securities."
One portfolio manager sees the allure of dividend investing, especially when compared against the backdrop of low interest rates. "The value of dividends has been highlighted by the environment, and first and foremost is just the low yields on competing assets," said Dan Hanson of BlackRock. Corporate bond yields recently hit a record low of 3.57 percent. Contrast this with the above-average dividend yield on a growing number of S&P 500 stocks.
Businessweek: recently pointed out that investors put more money in the S&P 500's dividend exchange-traded fund, the SPDR S&P Dividend ETF, in September than ever before, while the Dow Jones Industrial Average's dividend ETF, the iShares DJ Select Dividend Index, had its best month since January 2005.
Corporate cash is at unprecedented levels, which explains why so many publicly traded companies can afford to entice investors with higher dividends. Investment advisories have been giving increasing exposure to yield investing in recent months and you may have noticed that mainstream investment publications are also increasing their coverage of yields. I predict yield investing will be the investment watchword for 2011 and will be the "hook" necessary for getting many of the sidelined retail investors back into the market.
One trend that should help the financial sector in the months ahead is an increase in the dividends that banks pay out to their investors. According to an article appearing in the Dec. 5 issue of Businessweek:, "As the financial crisis eases and earnings improve, regulators may allow banks to start increasing their dividends." JPMorgan Chase and Wells Fargo are among the banks expected to increase their dividends as early as the first quarter of 2011. We've been emphasizing the dividend yield theme for 2011 and if the banks do in fact join the payout bandwagon it would serve to attract attention to a sector that has, in the last two years, suffered from a dearth of investor interest.
The increased attention the Wall Street press is giving to dividend investing should help keep the market's uptrend intact heading into 2011 as investors seek higher yields. Since the start of 2010, $274 billion has poured into bond funds, while $35 billion has been pulled out of stock funds. For the last two years, in fact, investors have hoarded money in low yielding bond funds and there is a growing body of evidence that they're getting tired of the paltry yields. They've sat back and watched the equity market bounce back since March 2009 while their bond funds have gone nowhere.
I don't advocate chasing yields for the simple reason that high yields tend to involve high risk. It's very easy to fall into the so-called "yield trap" and I'm beginning to wonder if maybe the quest for higher yields will lead to a mini bubble in 2011 heading into next year's 6-year cycle peak. Regardless, the increasing focus on yields in the financial press should lead to a steady stream of investment funds that should help keep the stock market's uptrend healthy for a few more months.
Let's turn our attention to the commodity that everyone is talking about right now. I'm referring of course to the shiny yellow metal. The gold price has also reached new highs and the rally in gold is another reflection of strong global demand. Many investors believe gold is a crisis hedge and attribute the rally in gold to the belief that the financial crisis persists. If nothing else the credit crisis of 2008 should have dispelled the myth that gold is the "ultimate crisis hedge" since it was dumped along with everything else in the rush to achieve liquidity two years ago. Gold does feed off investor uncertainty and concerns about deflation, regardless of whether those concerns are justified or not. It's the uncertainty factor more than anything else that fuels the desire for investors to stock up on gold.
The momentum bull market in gold over the last several months is driven by something more than fear, however. Gold's current rally is being driven by demand—industrial, consumer discretionary (jewelry), and growing affluence among people in emerging countries. It's also being pursued as a key asset among hedge funds who are always on the lookout for an asset with strong fundamentals that can be pushed steadily higher with minimum risk of a drastic price reversal. These are all factors one sees in a strengthening economy. Thus I view the gold rally as another reason for expecting more recovery in the global economy.
Michael Santoli recently tackled the question that some investors are starting to ask themselves, viz. "Is gold in a speculative bubble?" A few investment analysts recently have made the case that when John Q. Public becomes aware of a bull market, that market's days are numbered. Well the public is definitely aware of gold's recent success. Does this mean the gold bull market is doomed to soon to come to an inglorious end?
To answer this question we need only to go back to the 1980s at a time when the U.S. stock market was at a similar point compared to gold's 10-year bull market. Everyone was aware that stocks were a hot investment and upper middle class and wealthy investors definitely had exposure to stocks. Yet the working middle class weren't direct participants in the ‘80s bull market by and large. It was until about 15 years into the bull market that the average Joe became involved with the stock market boom. And by that point there had definitely developed an asset bubble.
When I look around at the current investor makeup of the gold market, I don't see much evidence that the public is heavily participating in this bull market. I see well-to-do investors participating but the public hasn't really bought into this gold bull run yet. Even silver, which is the traditional "poor man's gold," isn't exactly a hot commodity with the small investor (notwithstanding the mini-mania for owning silver coins a couple of years ago). Until we see broad participation from the retail crowd, I don't believe we'll see gold's bull market ending anytime soon.
I second Santoli's conclusion on the gold bull market: "But there are just too many sound reasons for people of wealth to continue pushing money toward gold, and there is too much of a discount being placed on gold reserves in the ground based on the valuations of gold-mining stocks, for this trend to fall apart with any drama anytime soon."
One of the reasons behind's gold's latest rally involves a shift of assets among conservative investors from low-yielding bonds into gold. In a recent issue of his Current Market Update, Jack Ablin of Harris Private Bank observes, "Historically, the opportunity cost for owning gold was considerable. However, now that three-month Treasury bills offer yields of a quarter of a percentage point, investors feel that they are leaving less on the table." Ablin points out that gold's year-over-year gains are typically consistent with a 2%–3% inflation rate. "Measured against other commodities, like crude oil, its gains are well within expectations," he concludes.
Gold's impressive rally this fall was fueled in part by seasonal demand from jewelry makers and by news that European central banks had sold only six tons of gold this year, out of 400 tons allowed to be sold from their reserves as part of a five-year European agreement. This represents more than 90 percent from their sales a year ago. Instead of selling gold, central banks purchased 222 tons from the IMF, which has played a role in increasing gold demand as well as the price per ounce.
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Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy. The forecasts are made using a unique proprietary blend of analytical methods involving cycles, internal momentum and moving average systems, as well as investor sentiment. He is also the author of numerous books, including "Gold & Gold Stock Trading Simplified." For more information visit www.clifdroke.com.