Making the Case for Stocks' Attractiveness

Includes: JPS
by: Roger Nusbaum

More so than in most issues, this week's issue of Barron's had a heavy emphasis on why US stocks are attractive. Repeated a couple of times was the book value argument, especially where financials are concerned. Although a reader took me to task a little on this the other day, the book values are not reliable for financials. And while the reader in question certainly may feel otherwise, the notion of questioning the book value is not something I thought of; I've seen this view expressed by many people far more knowledgeable than I'll ever be.

But there was one point made that seemed like grasping at straws, which is as follows:

Knapp looks at the so-called earnings yield on S&P 500, which is the inverse of the price/earnings ratio. It's now at 8% based on 2011 profits and 9% based on forward earnings projections. He compares the earnings yield with the real, or inflation-adjusted, yield, on 10-year Treasuries, which is now about zero. Ten-year TIPS, or Treasury Inflation Protected Securities, now provide yield above inflation. The current spread of about nine points between the forward earnings yield and the real Treasury yield is at its highest level since the early 1980s, which strongly favors stocks.

Stocks are cheaper than bonds now, but that does not offer any forward-looking help as stocks could stay cheaper than bonds forever. Certainly stocks could start going up from here in some heroic fashion (not my base case), but it makes no sense to me to use two different periods of interest rate analysis to draw the same conclusion when one period featured the highest interest rates of all time and the other period has about the lowest rates ever. This would seem to be beyond upside-down.

The other article to point at was about where to find yield now, given how low some rates are. Included with the various suggestions were closed-end funds for a couple of different segments. If you click through and look at how these CEFs did on Monday, you will see they got crushed. Take Monday as a microcosm: They recovered by the end of the week but these things occasionally get crushed the same as stocks (look at July 2003 and all of 2008). Two of the CEFs mentioned were down more than 8% on Monday. There were also a couple of fund products suggested that own closed-end funds, one of which was open end and the other closed (read the article if this sentence doesn't make sense) -- one of which was down 10% on Monday and the other down 6%.

I won't recap every product suggested. I will circle back to a point made often about how important it is to understand what these things are capable of doing. A portfolio of a bunch of CEFs that all go down 6-8% on a day that the stock market goes down 6% or that participate fully in a bear market decline would seem to be a bad idea for income investors. A small exposure to this volatile space can make plenty of sense in terms of lifting the yield of the entire mix a little and, if the exposure is moderate, then a big drop like on Monday is pretty easily absorbed.

One final point is that funds have no par value to return to (hopefully this is not the first time you are hearing this fact). A Nuveen closed-end fund with symbol JTP was launched in 2002 at $15 per share. It is currently at $7.65. Getting a 7% yield in a zero percent world means taking a lot of risk one way or another.