The Hierarchy of Risk and Return Are Returning to Normal
We are almost back to the full normal in our New Normal era.
Back to Normal
Warren G. Harding, considered a failure as president but world-class as a philanderer, campaigned in 1920 for "not nostrums, but normalcy." Sounds good; who, really, campaigns intentionally on behalf of nonsense; it just seems to show up on its own. I concluded a discussion of risk and return last February in Risk and Return Go Back to the Future:
We are almost back to the full normal in our New Normal era. If we map the excess total returns of the Russell 3000 Index (accessible via the iShares Russell 3000 Index ETF (NYSEARCA:IWV)), and the Bank of America-Merrill Lynch series for convertible bonds, high-yield bonds and A-rated bonds to the total returns for 7-10 year Treasuries since February 1990, we see only investment-grade bonds are underperforming Treasuries. Stocks finally have pulled ahead of high-yield and convertible bonds. The Earth revolves around the sun again, or whatever it was Copernicus said it did.
That last point can be reinforced by comparing the two equity-like bonds' total returns to those of the Russell 3000. Stocks pulled ahead of convertibles in January and high-yield bonds in March. The long hate-fest for equities reached its peak back in August 2011, right at the time when the federal government was talking about defaulting and the US' credit was downgraded. It also was the time when Operation Twist began and started making stocks, with the long effective durations, attractive relative to long-dated Treasuries.
Stocks should be able to continue this outperformance, even against convertibles; here the bonds suffer from low volatility and a concomitant decline in the gamma of their embedded call options. High-yield bonds' yields and credit spreads have declined to the point where they are attractive only in relation to Treasuries with their negative real yields for maturities of 10 years or less.
When Ben Bernanke hops into his Chairman's helicopter, Ink-Spray One, for his final ride into the sunset, he will turn to his biographer and say, "My proudest achievement was making reality conform to at least one financial theory." Everyone will nod; they always do.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.