U.S. stocks are a lot like late comedien Rodney Dangerfield: they're getting no respect, no respect at all
Indeed, equities are returning more than junk bonds after trailing them for a decade. But stock valuations have fallen to a record low compared with credit -- and investors are pulling more money than ever out of equity funds.
The Standard & Poor's 500 Index rose 17 percent including dividends since June, compared with 10 percent for the
Barclays Capital U.S. Corporate High Yield Index. The equity gauge is on pace for its biggest six-month gain against the bond index since 1999, data compiled by Bloomberg show. At the same time, the more than 120 percent rally in junk bonds since 1998 has left them more expensive than ever versus stocks, based on earnings yields measuring annual profits as a percentage of price.
“People have pushed the trade too far,” said Peter Sorrentino, who helps oversee $13.8 billion at Huntington Asset Advisors in Cincinnati. “The next step is to move from fixed instruments into stocks. Junk bonds have so little premium right now. It's like the last chapter where people are finally going to capitulate.”
Individuals are ignoring the advice, pulling $55.3 billion from stock mutual funds since the end of June after $11 trillion was erased from U.S. equity values between October 2007 and March 2009. Third-quarter withdrawals came as the S&P 500 rose 11 percent, the first time a three-month advance failed to spur investments, according to
LPL Financial Corp. in Boston.
Favoring Stocks
Huntington, PNC Wealth Management and
Goldman Sachs Group Inc. say stocks will beat speculative-grade debt as the economy improves. S&P 500 per-share earnings are poised to rise 37 percent in 2010, the biggest increase in 22 years, estimates from more than 10,000 analysts tracked by Bloomberg show.
The S&P 500 rose 0.5 percent to 1,204.90 as of 11:39 a.m. in New York.
The benchmark index for American equities fell 2.2 percent to 1,199.21 last week as profits from Cisco Systems Inc. in San Jose, California, and Burbank, California-based Walt Disney Co. trailed analysts' estimates. S&P 500 earnings that beat forecasts more than 70 percent of the time have helped push the gauge up 7.5 percent this year, data compiled by Bloomberg show.
Stocks remain cheap compared with bonds even after the rally. Debt rated below Baa3 by Moody's Investors Service and BBB- by S&P pays an average yield of 7.25 percent, compared with an earnings yield of 6.64 percent for the S&P 500, data compiled by Bloomberg show. That's the smallest gap since the Barclays index began in 1991.
‘Overweight' Rating
Goldman Sachs in New York advised clients last month to begin raising the proportion of equities they own relative to debt, citing the expanding economy. The world's most profitable investment bank lowered its rating on investment-grade corporate bonds to “neutral,” saying they were likely to return next to nothing while equities gain 14 percent over 12 months, according to an Oct. 15 note to clients.
Junk bonds, which Goldman rates “overweight,” will likely trail stocks, offering returns greater than 10 percent in the coming year, according to credit strategist Alberto Gallo.
“It's going to be harder for high yield to outperform stocks over the next 12 months,” he said in an interview. “We already had two years in a row where high yield did better.”
Investors should be buying stocks that “look like bonds” with international sales, below-average debt and growing dividends, said Chris Hyzy, New York-based chief investment officer at U.S. Trust, a
Bank of America Corp. unit overseeing $339.9 billion in client assets.
‘Sweet Spot'
“That's the sweet spot for a balanced investor looking to reallocate from excessive ownership of fixed income,” he said. “High yield is fairly valued. We expect the gap between the earnings yield on equities and fixed-income yields to close considerably in the next 12 to 18 months.”
Shares of retailers and technology companies such as J.C. Penney Co. and Motorola Inc. have surged since June 30, outperforming their bonds in a reversal of the first half, when equities slumped and junk rallied.
Department-store chain J.C. Penney in Plano, Texas, has returned 47 percent since June 30, compared with a gain of 0.02 percent for its senior unsecured debt, rated Ba1 by Moody's and BB+ at S&P. That contrasts with the first six months, when shares fell 19 percent and the debt rose 7 percent.
Motorola, the second-largest U.S. mobile-phone maker, has surged 23 percent this half, five times the 4.2 percent gain for its debt. In the first six months, Schaumburg, Illinois-based Motorola's bonds returned 16 percent, while its stock lost the same amount.
Rental Cars
Avis Budget Group Inc. shares rallied 38 percent since June 30, while the company's bonds returned 11 percent. Year-to-date, the bonds of the rental-car company have risen 16 percent, compared with 3.6 percent for the stock.
“If I had to add money into a portfolio, I'd add it into equities,” said James Dunigan, chief investment officer at PNC Wealth Management in Philadelphia, which oversees $105 billion. “Stock valuations remain attractive. The earnings prospects continue to be positive. We'll likely get back to an economy which is expanding in the early part of 2011.”
While the S&P 500's advance has restored $2.15 trillion to market values since July, shares are getting cheaper compared with profit forecasts. Income growth that analysts predict will top 13 percent in each of the next two years means the index is trading at 12.5 times 2011 earnings and 11 times projections for 2012, data compiled by Bloomberg show. The S&P 500's average price-earnings ratio since 1954 is about 16.5, the data show.
Quantitative Easing
At the same time, the Fed's so-called quantitative easing policy to buy as much as $600 billion of Treasuries has pushed down government bond yields that are the benchmark for corporate borrowing and mortgages. Rates on junk fell to a 5 1/2-year low of 6.97 percent on Nov. 9, from 9.5 percent five months earlier and a record 23 percent in December 2008, according to the Barclays Capital index.
“Quantitative easing is extremely supportive of equities in the short term,” said Lucette Yvernault, who helps oversee the equivalent of about 7 billion euros ($9.5 billion) at Schroders Investment Management Ltd. in London. “The detrimental impact of the QE is that investors don't necessarily reinvest in the U.S. economy, but instead fuel more growth in emerging markets.”
U.S. earnings may keep rising as more executives than ever increase forecasts compared with those lowering them. EBay Inc., United Parcel Service Inc. and 196 other companies raised profit estimates above analysts' projections last month as 130 firms cut them, the biggest gap since Bloomberg began tracking the data in 1999.
Greed Kicks In
The S&P 500's earnings yield averaged 5.6 percent through the last bull market that ended Oct. 9, 2007, according to data on reported profit compiled by Bloomberg. Using estimated income, the index yields 7.1 percent, 0.2 percentage point less than the average for speculative bonds tracked by Barclays.
“The greed will kick back in, and that's what will propel the equity markets,” Huntington Asset's Sorrentino said.
While stocks have beaten bonds in the past 4 1/2 months, investors have fared better this year with fixed-income securities. The Barclays measure of junk bonds has returned 15 percent since Dec. 31, double the advance in the S&P 500.
Investors piled about $190 billion into U.S. bond funds this year through Oct. 31, a pace that would surpass last year's record-setting $214.1 billion, according to Cambridge, Massachusetts-based research firm EPFR Global. Clients pulled about $56 billion out of equity funds and $74.6 billion in 2009.
Flows into junk bonds fell to $1.7 billion in October from $3.35 billion in September, the most all year, provisional EPFR data show. That brought the total to about $8.6 billion as of Oct. 31, compared with $19.9 billion in 2009.
“Ultimately the Fed will succeed,” said Wayne Lin, a money manager at Baltimore-based Legg Mason Inc., which manages $677 billion. “It's just a question of how well they will succeed and how long it's going to take for them to convince people to take money out of the mattresses and start putting it to work.”
