"All I have to do is to work on transition and technique." - Usain Bolt
It is no surprise to anyone that bond yields around the globe are at incredibly low levels, which in many cases has resulted in money willing to take a guaranteed loss after inflation for the "safety" of getting back principal. The pendulum has swung too far in favor of bonds relative to higher yielding stocks, yet many are still concerned with equities as an asset class. This is certainly understandable in the face of the negative narrative, and volatility surrounding Europe.
Having said all that, I maintain that the odds favor reflation and that the pendulum is likely to swing away from deflation and back into rising inflation expectations. The performance of financials relative to the S&P 500 shows some continued leadership despite last week's bank downgrades, as well as lingering concerns over JPMorgan (JPM). Utilities, which are an interest rate sensitive sector, are also showing some weakness, which suggests further improvement in the risk-taking backdrop. While equities are likely the most sensitive to any kind of return to reflation, preferreds likely can also perform well given their hybrid nature as a stock and bond alternative.
Take a look below at the price ratio of the iShares S&P US Preferred ETF (PFF) relative to the iShares Treasury Bond 20+ Year ETF (TLT). As a reminder, a rising price ratio means the numerator/PFF is outperforming (up more/down less) the denominator/TLT.
(Click to enlarge)
Notice the far right of the chart, which shows that preferreds may be on the verge of a real period of leadership relative to longer-dated Treasury bonds based purely on price. This does not factor in yield, which for PFF is stated at over 6%. Given that a substantial portion of the ETF is made up of Financials, this also means that any continued outperformance in the sector also benefits the fund as well. As such, preferreds in many ways are a good transitional asset class should reflation persist as the Summer Surprise of 2012.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Disclaimer: Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing.
