Friday, August 04, 2006
I showed last time how the Dow Jones Dividend Index has caught the S&P 500 Index, on a price basis, for the last 12 months. I made the point in that edition that such a big relative shift towards dividend paying stocks was related to the uncertainties of oil prices and supply, the bloodshed in the Middle East, and the belief that the economy is slowing. In the last few weeks, investors have shifted away from risk and growth toward quality and stability. Whenever I see big shifts in the market, I always look for corroboration from other significant indicators. If big, savy investors are on the move, they will leave a trail that will show up in other markets and securities. Today's chart is of the 30 year US Treasury Bond Yield. It holds many important clues as to what big investors may be up to. Click to enlarge. ......................30-Year T-Bond Yield.............. The chart is of the yield on a 30-Year T-Bond. The chart covers the last 12 months. A year ago the yield stood at about 4.6%. Rates stayed in a narrow band through the end of '05, even though the Fed was raising short rates. As it became clear, that economic growth was taking off in early 2006, the yield on the 30-T-Bond began a steady rise to near 5.25%. It was at this point that Fed chairman Bernanke started talking tough. The Fed does not control long rates, such as 30-Year T-Bonds; they are set by the market. Thus, the yield on the 30-year T-bond is a kind of monitor of how well investors believe the Fed is doing its job of fighting inflation. Rising rates on 30-year T-Bonds indicate the market believes the Fed is not tough enough; falling rates say just the opposite. From March through May of this year, the market was saying that the economy was growing too fast and ran the risk of pushing inflation higher, which drove rates higher. After Bernanke and other Fed members began to talk tough, bond investors were relieved and bond yields fell. But two straight higher-than-expected inflation reports at mid-year pushed rates back toward their 12-month highs. In July, as bond yields returned to their May highs, Israel and Hezbollah began bombing each other. Unexpectedly, bond yields began to fall and have continued to trend lower. At first, this may seem counterintuitive. After all, the war in the Middle East has pushed oil prices higher and rising oil prices will surely mean higher inflation, won't it? That line of thinking would conclude that interest rates should have risen when the shooting began. But thinking about it more broadly, falling rates make sense. Bond yield are falling primarily because of a flight to safety(T-Bonds are considered to be among the safest bonds on earth). Additionally, I believe, bond yields are now falling because of recent economic data that suggest the economy is slowing, and the recognition that $3.00 a gallon gasoline will extract a lot of money from consumers' wallets. Here's the bottom line: Bond yields look like they have peaked. That's good news, but what is even more important is the relative strength graph at the bottom of the chart. For most of the last year, the rise in T-Bond yields has been greater than the growth in stock prices. Since June, however, the S&P 500 has been outperforming bonds. This can be seen in the downward slope of the lower graph since that time. I believe the rally in dividend-paying stocks and the rally in bonds has the same root: The Fed is nearing the end of its rate hikes. That is the good news, but there is also a bit of bad news. If the Fed is ending its rate hikes, it must be convinced the economy is slowing, and a slowing economy will result in slowing earnings growth. The risks of earnings disappointments in the coming year are now on the rise. The rally in quality dividend-paying stocks and bonds in the face of all of the uncertainties is natural. Money always goes where it is treated the best, and history shows that in times of turmoil and slowing economic growth "cash is king." Dividend-paying stocks and T-Bonds are the best sources of high and predictable cash flow and they will continue to rally until the uncertainties subside.