If 2015 was the year that nothing worked, then 2016 is shaping up to be the year that everything worked. Bonds are up. Stocks are up. Real assets are up. Gold is up. Go ahead – pick your favorite asset -- it’s likely to be up as well.
Markets aren’t supposed to work this way. Every asset is meant to have its season. If investors are feeling peppy, for example, they’re supposed to buy stocks. If they’re feeling blue, they’re supposed to buy bonds. And those gold bars buried in the backyard, of course, are a security blanket for those occasional freak outs.
Actually, this everything-is-in-fashion alternate universe has been going on in the U.S. for many years now. The S&P 500 has returned a healthy 12.1 percent annually over the last five years through June 2016 (including dividends) – well above its long term average return of 10 percent annually since 1926.
At the same time, bonds have been on an epic run. Ten-year treasuries touched a low, low yield of 1.32 percent on July 6, a mark not seen since 1792 when the ink was still drying on the U.S. Constitution. (Bond prices and yields move in the opposite direction.)
The knee-jerk reaction to this whacky state of U.S. markets is that we are living through a great schism in investor sentiment. That view goes something like this: 1) Stock investors see a U.S. economy picking up steam after years of sluggish growth, 2) Bond investors see a hobbled U.S. economy overdue for the next cyclical downturn, and 3) One of them is terribly misguided.
But when you look more closely at where stock and bond investors have placed their bets over the last several years, it’s not clear that there’s any disagreement at all.
For starters, bond investors have chased more risk, not less. The Barclays U.S. Treasury 3-7 Year Index has a total return of 3 percent annually over the last five years (through the end of June). But credit did even better. The Barclays U.S. Intermediate Credit Index has returned 4 percent annually over the same period. And junk performed best of all. The Barclays U.S. High Yield Intermediate Index has returned 5.6 percent annually over the same period.
So much for cowering bears.
Stock investors flipped the script too, and have sought out less risk, not more. The S&P 500 Value Index has returned 11.2 percent annually over the last five years through the end of June (including dividends). The broader market, however, which includes both value and higher quality stocks, did even better. The S&P 500 returned 12.1 percent annually over the same period. And quality stocks bested them all. The MSCI USA Quality Index returned 12.9 percent annually over the same period.
So much for raging bulls.
Rather than some grand disagreement, in other words, it looks more like stock and bond investors have agreed to meet in the middle, which isn’t particularly surprising. There’s precious little return to be had, after all, in safe investments such as treasuries in an era of hyper-stimulus, and there’s heightened risk in value companies in an era of endlessly sluggish growth.
But after having been handsomely rewarded over the last several years, U.S. investors can now agree on one more thing: The middle looks crowded.
High yield bonds, for one, aren’t cheap. Yes, junk bond yields have risen over the last two years, but the current yield on the Barclays U.S. High Yield Intermediate Index is 7.9 percent, which is still well below its historical average yield of 10.4 percent since 1987 (the earliest year for which data is available).
Quality stocks, too, are no bargains. The earnings yield on the MSCI USA Quality Index is 5.4 percent (calculated using three-year trailing average earnings), whereas the earnings yield on the S&P 500 Value Index is a more generous 6.5 percent.
Some big time money managers are bemoaning the dearth of attractive investment options. Larry Fink is worried about the sustainability of U.S. stock prices in the face of declining U.S. corporate earnings. Howard Marks sees markets that are offering low returns, but high risk. Bill Gross and Jeffrey Gundlach see high risk in traditional safe havens like government bonds.
Investors still agree that the current investment environment is precarious. Just don’t expect consensus any longer about how to deal with it.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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Nir Kaissar in Washington at firstname.lastname@example.org
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