The Financial Times ran
of profound importance recently, but it seemed to go largely
The U.K.-based newspaper reported that brokers including Merrill
Lynch believe that stocks are becoming safer long-term investments
than government bonds. This corresponds with some of my own
research and helps explain recent price action in the S&P 500.
It's difficult to express what's happening because I believe that
we are nearing a true paradigm shift in the world of finance and
investing. Attempting to make specific predictions is a fool's
game, but certain factors are lining up in a way that suggests
we're near the beginning of a new bull market. It will have its own
causes and attributes that will unfold over a period of years
rather than months.
Put simply, I believe that stocks are underowned and that
Treasuries are overowned. We are nearing a point where the marginal
dollar will increasingly flow into equities over bonds and where
money will gradually migrate away from "safe assets."
First, it's important to realize that Treasuries have enjoyed the
greatest bull market in history since 1980, with yields
consistently ticking lower in good times and bad. They now seem to
be near levels where they can fall no further. (The Fed can't push
rates much lower, and the
10-year Treasury yield
seems to have formed a
in the last two months.)
Second, government bonds are now showing all signs of a bubble in
its final stages, with people plowing money into them
indiscriminately. Supply has surged in response--just the same as
Latin American debt in the late 1970s, dot-com stocks in the late
1990s and residential mortgages in the middle of the last decade.
Third, assets similar to Treasuries have already started to fail.
Remember Fannie Mae and Freddie Mac? Also, look at sovereigns in
Europe and municipalities in California. Mortgages are another case
study because they had been and supported by the federal government
since the 1930s. Roll back the clock 10 years, and none of those
assets were priced based on credit risk; they were based only on
In some ways, the crises of the last five years resulted from
nothing more than the market waking up to the credit risk in
mortgages and sovereign debt. But that consideration of credit risk
has not yet been applied to Treasuries. How many investors, after
all, analyze the creditworthiness of the U.S sovereign before
buying bonds? (Answer: None.)
There is no denying that U.S. public institutions have become
increasingly weak--just look at the state of Congress and the
budgetary process. In the last decade, government spending has
surged to about 140 percent of revenues from 110 percent while
total debt has almost tripled.
In the same period, companies have done the exact opposite and
grown increasingly strong. Their profits have risen from 3 percent
of GDP in 2002 to more than 8 percent now, and they're better
capitalized than at any other time since World War II.
In fact, a longer-term view is important because the 20th century
was a period of powerful governments and weak companies. The trend
started during the Great Depression and continued during WWII and
the Cold War, when the state in various ways promoted innovation
and investment in such areas as aerospace, medical research, and
But we must never forget that modern capitalism actually began in
the 19th century. That's when companies and private individuals
ruled the world--there were no Treasuries.
Something similar seems to be taking shape again. It doesn't mean
to chase stocks at the highs, but it does mean to buy the dips and
enjoy the ride.
(A version of this article appeared in optionMONSTER's
What's the Trade?
newsletter of July 18.)