You might recall that in December I posted the adjacent chart, recommending that the spread between equity yields and treasuries was “NUTS” and a narrowing of the spread between more risk and less risk would favour stocks. It remains in the best interest of governments globally (the U.S. naturally being the anchor point) to keep interest rates as low as possible, given their leveraged balanced sheets and the continuing fallout in economic terms from the financial crisis (weak housing demand in the United States, financial turmoil in Europe, slowing in Asia).
The bottom line is that the 1st quarter of the year delivered the rally that was logical to expect. Most investors and even a high percentage of experts have difficulty making rational judgements when the press and consensus thinking are biasing their thought processes. Behaviour psychologists call this phenomenon ‘accessibility.’ Your brain accepts the easiest (accessible) information – research reports, the press, recent conversations and unscientific observations – and gives far too much weight to them. Easier to make a quick judgement than overwork those lazy brain cells. Emotion has a large influence also, causing decisions to be made on wrong data believed to be correct. An example: If I pointed out a man in a suit, short haircut and glasses not smiling, and asked what type of smart phone he uses – you’d probably say a Blackberry. You stereotype (bias) rather than assess the probabilities. The data suggests that since there are so many more iPhone users, that the odds are greatest he too uses an iPhone.
Because the press and commentary from experts continues to be emotionally charged it is a good bet that the reasonable equity returns witnessed are tainted by a measure of disbelief, or more likely the investing masses are oblivious. For the rest of us, the trend is your friend. Have a look at the below updated chart. Either earnings yield for the stock markets continue to decline, or treasury bond yields rise significantly. There’s a good chance a combination of both can occur but this is only good news for stock prices (they rise causing yield to fall) since rising treasury yields will hurt bond owners. Small moves in interest rates at these low levels has a large impact on bond prices.