January 16, 2013 | By Scott Minerd
“It appears that we are in the early stages of a generational shift favoring equities over bonds. While we may have some periodic setbacks, equities will likely outperform bonds for a decade or more. Many investors are becoming disillusioned with the low yields available on bonds, especially U.S. Treasury securities. With a negative total return for Treasuries during the second half of 2012, the downside risks in the fixed income market are coming into clearer focus. Equities are seen as a compelling alternative to fixed income, both from a dividend income perspective, as well as for their potential upside from price appreciation. Investors see little potential for price appreciation in bonds, and the attendant downside risks are increasing. If investors are forced to accept increasing downside risk in fixed income, similar risks in equity investments become more palatable.
Problems could arise in the bond market if the Federal Reserve announces it will sell fixed income assets from its balance sheet. We will probably get a taste of that when the Fed ceases buying securities with the end of quantitative easing, but that will just be ‘normalization,’ not tightening. Treasury buyers are safe so long as another buyer exists, although the endgame will likely resemble musical chairs – bondholders will try to leave the market when the music stops, but with fewer spaces available, there will be a lot of losers.”
Global central banks’ accommodative monetary policies over the past two years have lowered interest rates and pushed bond yields to new lows. Since early 2011, ratios between dividend yields of equity benchmark indices and yields of aggregate bond indices have risen in all major global markets. Although this does not necessarily mean that equities are superior to bonds on a risk-adjusted basis, it does show the increasing attractiveness of equities from a dividend-income perspective. Given the abundant liquidity across the world courtesy of global central bank actions, equities may outperform bonds as investors migrate to asset classes which offer higher potential returns.
Source: Barclays, MSCI, Bloomberg, Guggenheim Investments. Data as of 1/15/2013. *Note: MSCI equity dividend yields are trailing 12-month based. Regional aggregate bond indices consist of fixed-rate investment-grade bonds. Emerging markets aggregate bonds are denominated in U.S. Dollars.
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