JPMorgan’s Kelly Says Fed-Fueled Bond Bubble Makes Stocks a Buyby
Chief global strategist calls bond markets ‘distorted’
Says earnings will be up one year from now as oil impact fades
Central bank policies are distorting the bond market and creating a bubble in fixed income, according to JPMorgan Chase & Co.’s David Kelly, who advocates owning equities instead.
Easy money policies around the world have sent bond prices soaring, making equity markets the most attractive asset class for investors seeking income, Kelly, the chief global strategist at JPMorgan Asset Management in New York, said in an interview on Bloomberg <GO> Thursday.
The S&P 500 Index is trading at about 19 times annual earnings, close to the highest in a decade, though compared with bonds valuations are less stretched. Profit as a proportion of share price, known as earnings yield, is about 5.3 percent in the equity benchmark, about 3.75 percentage points higher than the 10-year Treasury rate. That’s a bigger valuation advantage for shares than any time during the 2002-2007 bull market.
“Stocks are not ridiculously expensive,” according to Kelly, who says earnings are being dragged down disproportionately by energy and commodity companies. Profit multiples are “not that unreasonable relative to what we’ve seen on average and certainly not unreasonable relative to the bond market. What’s out of whack right now is not stock valuations, what’s out of whack are bond valuations.”
Kelly recommended owning equities as share prices were bottoming four months ago. On Feb. 12, as the S&P 500 began its bounce from a two-year low, Kelly said in an interview that the selloff that had pushed stocks to their worst start to any year was “illogical.”
Bond yields are plunging around the world in 2016 as central banks from the U.S. Federal Reserve to the European Central Bank and Bank of Japan maintain near-zero and sub-zero interest rates in hopes of stimulating economic growth. On Tuesday, Germany’s 10-year government bond yield dropped below zero for the first time on record.
In the U.S., the 10-year Treasury yield is down 33 percent so far this year to 1.55 percent. Two-year yields tumbled Wednesday after the Fed stood pat on interest rates, citing mixed American economic data, the threat of the U.K. leaving the European Union, and a sluggish global economy.
While Kelly said bonds are in a bubble, he cautioned usage of the term. Fixed-income bubbles don’t carry the same ramifications of those in equity markets, where Kelly is less concerned about valuations. When asked about declining profits, the strategist said they are not in recession, even though S&P 500 earnings have fallen for four straight quarters.
“It’s not broad-based,” he said. “This is the dollar and it’s oil and they’re both going to bounce, so if we’re back here watching the fourth quarter earnings season in January, we’re going to be talking about big year-over-year gains in earnings as those headwinds fade.”
So where should investors spend their money? European stocks, according to Kelly.
“Don’t go to the bond market, which is completely distorted by central banks, to get income,” Kelly said. “If you’re asking how to get a good return over the next five years and a good income in the meantime, I think stocks in general are better than fixed income and personally, around the world, I like European stocks.”