This morning the 10-year US Treasury
(^AXTEN) note yield hit an all-time low. Despite all-time lows in yields, investors can’t seem to get enough bonds. Investing in bonds now bears similarities to investing in stocks 12 years ago or real estate six years ago.
From 1925 (when monthly data starts) to December 2010, the lowest monthly close for the 10-year bond was 1.98%. This occurred in July and October 1941. Bonds then proceeded to go into a forty year bear market. The 10-year bond yield will finish at the lowest monthly close in history (the current record is 1.80%) in May 2012.
Here is the annual chart of the 10-year note yield since 1800:
So we are at historical lows for bond yields on an annual, monthly, daily, and intraday basis over a time span covering at least 212 years. What happens when a major asset trades at an all-time yield low? Stock’s all-time (data starts in 1873) monthly peak earnings yield low was on June 30, 1999 at 2.99%. The secular stock bull market ended less than nine months later. Real estate capitalization rates traded at an all-time (data starts in 1951) low in 2007/2008 at about 5.5%. That didn’t turn out too well, either.
The Earnings Yield - Bond Yields Indicator.
On September 30, 2011, stocks had an earnings yield of 5.27% more than the 10-year note. In the last 56 years, there have only been two months (out of 672) where the spread was higher than that at the end of the month. Those months were September and December 1974 at the double bottom of the 1973-1974 bear market. Stocks started a 125% six year bull market on October 3, 1974.
On the flipside, the low for peak earnings yield-10-year note over the last 24 years was on January 31, 2000 at -3.16%. The great secular equity bull market ended less than two months later.
Is this indicator predictive?
The all-time high for peak earnings yield-10-year note yield was on June 30, 1932. Stocks proceeded to go up 110% over the next two months and seven days. This was at the best time to buy stocks in the 20th century.
The all-time low for peak earnings yield-10 year note yield was on September 30, 1987. Stocks proceeded to drop 32.7% in less than 20 calendar days.
Nasdaq 100 up 14 weeks in a row.
Since Nasdaq’s 1971 inception, there have been three times that the Nasdaq 100
(^NDX) went up more than 11 weeks in a row.
March 10, 1972: There was a 13.94% correction in the S&P
(SPY) from April 28 to November 23, 1971. Then there was an explosive move upward in stocks, which culminated in 15 consecutive up weeks in the Nasdaq 100 on March 10, 1972. The stock bull would not end for another 10 months. Over the next 9.5 years, bond yields would go up 162% with no downside.
Jan 15, 1999: There was a 19.1% correction in the S&P from July 17-October 8, 1998. Then there was an explosive move upward in stocks, which culminated in 14 week consecutive up weeks in the Nasdaq 100 on January 15, 1999. The stock bull would not end for another 14 months. From January 15, 1999 to January 21, 2000, the 10-year note yield would go up 46%.
April 5, 2012: There was a 19.3% correction in the S&P, which ended on October 3, 2011. After a few months of backing and filling, the Nasdaq 100 went up 14 weeks in a row between early January and April 5, 2012.
After these big winning streaks (in the first two instances), the stock market spent a couple of months consolidating its gains by backing and filling before staging the next move higher. It is probable that the same phenomenon is playing out now.
Here is a list of other Nasdaq 100 weekly up streaks in the double digits:
11 February 20, 1976
11 May 19, 1978
10 February 3, 1989
11 June 9, 1989
11 December 31, 1999
The only one of these that was near a stock bear market was the December 1999 streak (March 2000 was the peak). However, you may recall Nasdaq was up 85% in 1999. The move was more of a blow-off top than the beginning of a new up leg like the recent situation. Even in that case, the market still had one more leg higher left for a couple months. It would be unprecedented to reach its exact peak after being up so many weeks in a row.
In summary, bond yields are at all-time lows. Stocks’ earnings yield is much higher than bond yields. The Nasdaq 100 was recently up 14 weeks in a row. All signs point towards outperformance of stocks over bonds until at least next spring. In addition to buying stocks, traders should strongly consider not only selling bonds, but shorting them as well.
No positions in stocks mentioned.
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