Tuesday, 12 June 2007

Not the end for bull market in stocks

Reuters has an article saying that investors continue to favour equities over bonds despite the recent rise in bond yields.

[A] straw poll of European-based investors conducted by Reuters on Monday suggests 10-year Treasury yields would have to rise beyond 5.6 percent from current levels around 5.15 percent to prompt a significant switch to bonds from stocks...

The reason institutional investors have so far remained sanguine is the view that the rise in bond yields has been driven not by a big upward shift in inflation expectations but rather by an improved outlook for the global economy...

A Morgan Stanley survey of 41 of its largest European hedge fund and long-only clients last week found that, despite worries about inflation and interest rates, equities remain easily the most popular asset class for the coming 12 months.

Some 85 percent expect equities to post positive returns in the coming 12 months, with 43 percent expecting returns of 10 percent or more.

That is despite almost one fifth of them predicting U.S. 10-year yields above 6 percent in a year and 70 percent expecting yields of 5 percent or above.

The key reason for the preference for equities: earnings yield on equities remain higher than bond yields. Reuters cites Michala Marcussen, strategy director at Paris-based Societe Generale Asset Management:

She estimates the earnings yield on U.S. equities is currently around 6.25 percent, based on the average price-to-earnings ratio of stocks.

The real yield on 10-year Treasuries, meanwhile, is around 2.6 percent -- 5.10 percent nominal minus around 2.5 percent inflation.

That gives U.S. stocks a roughly 3.7 percent premium over bonds, some 70 basis points above the 3 percent premium many consider to be a floor for investing in riskier stocks.

Ticker Sense provides the P/E ratios of various stock markets around the world and shows that relatively favourable valuations is a worldwide phenomenon.

But John Authers at FT points out that although bond yields remain relatively low, a 20-year trend of falling yields has been broken.

This is not yet the end of the five- year bull market in stocks. At 5.1 per cent, Treasury bond yields remain low by historical standards. But it may mark the beginning of the end.

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