One of the most frequent refrains I have heard over the past year is, “I have to buy stocks. There is just no yield anywhere else.”
This train of thought has driven investment flows in the past year. It has led to the rush into defensive stocks in 2013. Health care, staples, and utilities are still the best performing sectors in the U.S. Emerging market bond and high yield bond ETFs have seen massive inflows. And it has led to a desperate retreat from holding cash.
I acknowledge that yields are very low. In fact, one look at global government bond yields this morning shows that unless you want to buy Greek, Portuguese, Spanish or Italian debt, sovereign yields are all at or below 3% (country on far left, yield on far right):
So yield is very low. Equity yields are frequently higher, around 3% on average in the defensive sectors. Almost double the 10 year Treasury yield. And it’s been a great trade for years now. You have received the extra yield as well as the stock appreciation.
But basing your entire investment thesis on relative yield is a dangerous strategy. When the only argument I hear is yield, it reminds me of this chart that I posted last year, courtesy of Abnormal Returns by way of the FT:
The usual interpretation I have heard is – bond yields are below stock yields for the first time in 50 years, so stocks are a great buy. But my thought when I first saw the chart was – bond yields remained below stock yields for the entire first half of the 20th century, and that was a poor time to own stocks relative to the second half of the 20th century. So maybe low bond yields are not such a good long-term reason to buy stocks.
Stocks certainly could outperform bonds over the next 5 years, especially given bonds’ strong performance in the past couple decades. But relying simply on relative yield as justification is grossly insufficient, and oversimplification at its worst.