A year ago, stocks were extremely cheap, Treasury bonds were extremely expensive, and investors were extremely frightened.
The following is a weekly commentary written by David Kelly, chief market strategist at JPMorgan Funds.
A year ago, stocks were extremely cheap, Treasury bonds were extremely expensive, and investors were extremely frightened. Since then, both financial markets and investor attitudes have moved away from the extremes.
The S&P500, which closed at a low of 677 on March 9th, 2009, has since risen by 77%. The 10-year Treasury yield, which hit a low of 2.08% on December 18th, 2008, has since rebounded to 3.89%. And investor confidence, to the extent it can be proxied by consumer confidence, has also staged a significant rebound from its financial crisis lows.
All of this has occurred in an environment of improving economic conditions and prospects. But the economic improvement, while welcome, has been less dramatic than the move in the markets. Stocks still look cheap, trading at less than 15 times the roughly $80 which S&P500 companies are expected to earn this year. Moreover, 10-year Treasury bonds still look expensive, sporting a real yield of 2.6% (over core inflation) compared to a 2.8% average spread over the past 20 years. Prospects for both strong profit growth and a burgeoning supply of Treasuries remain positive for stocks and negative for bonds.
So while the case for over-weighting stocks relative to Treasuries is not as compelling as it was a year ago, it still remains solid and should be supported by numbers due out this week.
Trade data, due out on Tuesday, could show a slight widening of the trade gap but would reflect a generally healthy expansion in both imports and exports. The March retail sales report should be a blockbuster, bolstered by strong improvements in both chain-store and vehicle sales. Industrial production should have risen strongly in March based on numbers already released with the employment report while consumer sentiment ought to be experiencing some bounce from more general media reports that the worst of the economic crisis is over.
First quarter earnings reports from 21 S&P500 companies including General Electric, Intel, Google, Bank of America, JPMorgan Chase, CSX and Alcoa should give us a broad read on the health of the corporate sector in early 2010 and the pace of the profit rebound. Recent history suggests that most of these earnings numbers will surprise on the upside.
These numbers, on their own, would be negative for Treasuries. However, on the flip side, housing starts appear to have remained very weak in March while consumer inflation appears to have remained quiescent. In addition, Treasury data, due out on Monday, should confirm the Congressional Budget Office's usually very accurate read on the budget, showing a significant year-over-year improvement in the March budget deficit. These numbers, if confirmed, also suggest that the fiscal 2010 budget deficit may come in below the $1.416 trillion in red ink racked up in fiscal 2009, in contrast to the forecasts of both the CBO and the Administration. All of this suggests that while a growing federal debt should push Treasury interest rates higher, the risk of a huge rate surge is beginning to moderate.
The potential opportunities and risks which financial markets offer today are far less extreme than they were a year ago. However, they still remain and in roughly the same direction. Regardless of how investors allocated their money in 2008 or 2009, in 2010, there remains a solid argument in favor of overweighting stocks relative to Treasuries.
