Stocks vs. Bonds: Risk-Takers Can Make Historically High Returns

US treasury rates are at all-time lows, and the shortest maturities are straddling zero percent interest. First, let us highlight that zero, or worse - negative interest rates, makes almost no sense and cannot be sustained. For this Stalwart, they are a sign of true panic without refrain to logic. Basically risk-averse investors might as well put their money under "the mattress". For financial institutions, by using the term "mattress", I mean other forms of government-insured financial accounts that earn more, or at least earn nothing. Heck, buy some corporate bonds backed by a rock-solid corporate with little leverage. They are probably more solvent than the US government and will pay you substantially more.

I suspect that what is happening is that a lot of institutions just want by-the-book safety and their mandates or systems make US government bonds the most practical way of doing this. It's a clear inefficiency which cannot last since companies can over time put their money under "the mattress", as described above, have the same risk-free investment profile (risk-free defined as assets backed by the US government, the world's current "risk-free" standard) and probably do better than short term government bond rates. They can also assume a tiny bit of risk with a solid corporate bond and earn substantially more. But many institutions probably see less potential blame in investing in US bonds and prefer safety with the rest of the herd. Still, current ST rates seem unlikely to last and point to substantial relative value in risk-taking assets.

One surely has to give US stocks a second look given their valuations vs. US bond yields. In MBA speak, risk premiums are extremely high due to low stock valuations vs. earnings power and contrasting tiny risk-free returns, thus risk-takers are likely to get paid historically high returns per unit of risk assumed in the current environment, i.e. for the same amount of risk you might have taken a year or two ago, you are now likely to get paid a lot more to assume that same amount of risk.

Not to say that one should throw caution to the wind; the hard part is gauging how much risk you might be assuming so that the potential payback makes sense. But if one currently has the ability to hold risk-taking assets, then now is actually a better time to go and do so - better than any time in the last few years, even though it may not feel that way.

Comments

[headlocal:]

Right about this being a good time to get paid well to take on risk. But...will it be even a better time to take risk later, when a few more cockroaches have surfaced (Madoff II, III...) and the next quarter's round of 401K reports creates another wave of redemptions at Fidelity, Vanguard etc. We are about to enter the most uninspiring earnings season in recent memory, and the outlooks can hardly be expected to uplift the multitudes.

Still, stand ready to jump opportunities as they reveal themselves.

And, good luck folks.

Jan 02 06:37 AM