Stock Squeeze! Look For All The Money You Can Invest In The Stock Market

Includes: DIA, SPY
by: The Dividend Guy

I’ve carefully been looking at the market, and what I see is beautiful. While several investors are calling for the next Black Swan, I see many reasons why stocks will continue to rise for a good while.

By definition, a Stock Short Squeeze is when short sellers are forced to buyback the stock they are currently short since the stock keeps going higher and higher. When an investor thinks there is a short play (e.g. a company stock will eventually drop as it is overvalued), the investor can short sell the stock. The point is to sell a stock he doesn’t own in his portfolio since he thinks he sell the stock is now at a price of e.g. $40 without owning shares and buys it back (to cover his position) at $25 after the drop occurs. However, if the investor is wrong and the stock keeps going higher, he will be forced to buy the stock at $60 instead to cover is sale at $40. This is a stock short squeeze.

I’m taking this expression and calling it simply a stock squeeze for the market in general. The high demand for stocks is pushing their prices (and valuations) to higher levels each month now. Is it a bubble growing or simply the fact that stocks are in demand right now? Let’s take a closer look…

From Bonds to Equity

After 2008 and for a few years after, there was a massive amount of money that had left equities to go back into bonds and money market funds. Investors sold their positions and went “on the side lines” to watch the game.

After the interest rates dropped around the world, bond values naturally went up by a lot. This situation was good for a few years but the good old days of a bond portfolio making 6-10% is over. Interest rates have been at their lowest since the end of 2008 and as older bonds mature, they are replaced with very low yield investments. Plus, the more you wait until maturity, the more the capital gains created on paper due to the interest rate drop disappears (as you are receiving the high interest in your pocket).

This is why investors looking for income have no other choice but to consider stocks again to make sure they beat inflation and don’t take too much risk on their capital. This is why we see the same money that had left equities a few years ago coming back and increasing the demand for stocks…especially dividend stocks!

Record Profits Keep Climbing

During the first quarter of 2008 (right before things went sour during the summer), the S&P 500 P/E ratio was at 21.90. As I’m writing this article, the P/E ratio for the fourth quarter of 2012 was 16.49.

In other words; you are paying less for a stock today than in 2008 for the same profits. The good news after that is that there is no current bubble right now. The S&P 500 is not doped by some irrelevant techno stock valuation model based on visitors instead of profits. It’s not doped by the ever increasing housing value generated by unlimited access to ATMs for consumers. Profits are just great in a tough economic situation. Can it go higher? Asking the question is answering it.

Share Buybacks through the Roof

How many share buyback program announcements have you read about in the past 18 months? Listing them would take me forever! The reality is that several companies have lots of liquid cash in their bank accounts and they all decided to support their stock values (read pushing it forward) by buying back their shares massively.

This is another factor pushing the demand for stocks on the market.

Dividend Yield Still Over Bond Yield

There is a simple concept in investing: when the average S&P 500 dividend yield is over the 10 year Treasury note interest rate, it’s time to buy the market. Here’s the answer to your question:

The return from dividends since 2009 is sitting at 2.60% while the 10 yr Treasury note shows a 1.68% interest payment. Do you understand better why investors are leaving bonds to buy equities

What I like the most about this graphic is the recent spread between the dividend yield and interest rates. While the FED is pushing interest rates down with their bond buyback program, many companies increased their dividend payouts. This is definitely a great combination for dividend investors!

Interest Rates to Stay Put

There is not much to say about interest rates these days. We are running under a stormy cloud where Governments don’t want to increase interest rates any time soon. The FED won’t do anything until 2015 and chances are that many other countries will do the same. Actually, the European Central Bank and the Central Bank of Australia both decreased their rates lately. The International Monetary Fund is even considering a negative interest rate for banks who wants to put their cash in their bank account instead of lending it!

In other words; lending is cheap, companies will benefit from that and profits will continue to increase accordingly.

For these reasons, I’m bullish for the rest of the year… and I’m actually going to make some trades in the near future...