Yields Suggest “Unloved”
Interest payments on 10-year Treasury notes are fixed over the life of the note. Dividends for companies in the S&P 500 Index have grown through the years. As seen in Figure 1.5 of year-end yields for the 10-year Treasury and the S&P 500 Index, the yield is usually higher for the 10-year Treasury. Investors are willing to accept a lower current yield on stocks because they expect the dividends to grow. Since 1962, the yield on the 10-year Treasury has exceeded the yield on the S&P 500, on average, by about 300 basis points.
Figure 1.5 Yields: S&P 500 and 10-Year Treasury 1962–2020
There have been six times when the yield on the S&P 500 Index has been greater than the yield on the 10-year Treasury: year-ends 1962, 2008, 2011, 2012, 2019, and 2020. Once the two were about equal: year-end 2015. What was going on these seven times to reverse a normal, rational yield relationship? News events at the time of a few of these could explain investor behavior. The Cuban Missile Crisis was October 1962. The financial crisis was October 2008. The European debt crisis round two was September 2011. Investors were obviously afraid of owning stocks and were clinging to the safety of Treasury notes. They sold stocks and bid up the price of the Treasury notes, which lowered their yield. Five times during this multiyear bull market, investors disliked stocks so much, we were offered a higher yield on the S&P 500 than on the 10-year Treasury, despite the potential for the S&P 500 to provide dividend growth and capital appreciation. We had not seen this desperate yield relationship for forty-six years, then it appeared five times just before and during this multiyear bull market.
When the yield on the S&P 500 is equal to or exceeding the yield on the 10-year Treasury it signals that stocks are cheap and bonds are expensive. It is telling us investors like bonds and dislike equities and has been a very good “buy” signal for equities. Table 1.3 shows the rates of return for the S&P 500 for one and two years after the seven times of unusual relative yields.
Table 1.3 Rates of Return for the S&P 500 (%)
| Year | One-Year | Two-Year |
|---|---|---|
| 1962 | 22.8 | 42.9 |
| 2008 | 26.5 | 45.5 |
| 2011 | 16.0 | 53.6 |
| 2012 | 34.6 | 53.0 |
| 2015 | 12.0 | 36.4 |
| 2019 | 18.3 | ??? |
| 2020 | ??? | ??? |
Other Assets
It might have been alright to miss out on the bull market in domestic equities if similar returns could have been earned in other types of assets, but that is not the case. Domestic equities were clearly the sweet spot of investing during the multiyear bull market. Figure 1.6 shows cumulative returns for 2009 through 2019 for the S&P 1500 Index, Gold, the Commodities Research Board (CRB) Index, three bond indexes, and the Consumer Price Index. Although the nonstock assets beat inflation, they trailed equities severely. The stock market was the place to be and missing out on the bull market was a big deal.
Figure 1.6 Cumulative Return 2009–2019
Does Rate of Return Matter?
You bet it does. From the low on March 9, 2009, to the peak on February 19, 2020, the S&P 500 Index gained at an annual rate of 18.3%. We will not use that for this example because it was above average and exceptional. Let's tone it down and use 10% per year, right near the historic average for equities. Figure 1.7 shows the growth of $1.00 over twenty years at 10% per year. It also shows the growth at 5% per year, a rate slightly above what the public fund pension plans earned during the bull market.
Of course, for the public funds the starting amount could easily be $1 billion, so after twenty years there is a $4 billion gap for each billion invested. Even after ten years the gap is almost $1 billion per billion invested. For an individual investor, if the starting amount is $100,000 the difference is over a $400,000 after twenty years. The same math applies to financial advisors for whom the primary determinant of the value of their practice is assets under management. The higher returns earned by the investors, the more the value of the practice grows. Rate of return and participating in bull markets matter because if the goal for retirement is to buy a residence in a tropical location or to travel, the seller of the residence or the travel agent doesn't take risk-adjusted returns. They take money. If the investor can tolerate a little volatility, the market can do the heavy lifting to get to retirement goals.
Figure 1.7 Compounding at 10% and 5%
A couple of years before the end of the eleven-year bull market, I was working out at my fitness center in Naples, Florida. A stock market channel was on most of the TVs and the market was up that day. One retired fellow joked to his buddies, “If the stock market keeps going up, I'll actually be able to afford my life style.”
Top Ten Reasons I Missed the Bull Market
Throughout this multiyear bull market we wrote papers addressing concerns such as unemployment, inflation, deflation, double-dip recession, rising interest rates and monetary policy, and so on that were keeping investors from being invested. These conditions will be addressed in more depth in later chapters. Our presentations were logical and full of data and statistics, but we suspect not successful in getting investors to overcome their fears. In 2015, we tried a different approach and poked fun at investors who were missing out on the bull market. We borrowed from David Letterman and his top-ten lists that he used on his “Late Night Show.” We could not limit the list to ten, so we called it “The Top 15 Reasons I Missed the Bull Market.” Here they are as written in 2015:
1 15. I didn't notice S&P 500 earnings have grown 107% from 2008.
2 14. After 2008, I changed my risk tolerance.
3 13. I am stuck in the 1970s and thought inflation would come back and interest rates would rise.
4 12. I was waiting