If we don’t have a recession, equity prices are inexpensive from a valuation and dividend yield standpoint.   Since 1958, 10 year bond yields have always been higher than stock dividend yields (except during the fear laden 2008-2009 financial crisis).  Today the opposite is true, stock dividend yields are higher than the 10 year treasury yield.   When compared to bonds, stocks are cheap.

September 12, 2011

Jobs are hard to come by in the U.S. because we are going through a cycle of serial deleveraging.  In 2008 and 2009, U.S. corporations cut to the bone to make sure they could survive the great recession and the liquidity crisis.  At the same time, U.S. households started to spend less and pay down debt and this household deleveraging may last for an extended period of time. State and local governments started to deleverage in 2010 and earnestly started cutting budgets in 2011 because the impact of declining property and sales taxes have reduced their revenue streams. Because local governments are required to submit balance budgets, their deleveraging efforts may continue for some time also.

The Federal government just started to deleverage this Summer and it, like U.S. households will be deleveraging for a long time (especially if economy does not grows at more than 1%).  The big question facing the equity market is can serial deleveraging become a vicious cycle that  leads to a path of deflation.  Until we know see the impact of any jobs package, we are years away from knowing the answer to that question.

The European Union started to talk about deleveraging last year and applied a band aid to Greece.  Due to the structural difference between member countries, this deleveraging effort may require a rewrite of the entire European Union agreement.  The more the pain the quicker this will occur.

Serial deleveraging combined with the U.S. baby boomer retiree demographic leads to an interesting outlook for interest rates.  Retirees generally want a steady source of retirement income with low risk from their savings and this usually leads to an increased demand for fixed income investments. This increased demand for fixed income investments potentially keeps interest rates low for a long time and low interest rates are good for deleveraging.

This leads us to the question of where to invest. U.S. Equities are cheap when compared to U.S. bonds.  We believe that is the reason why the markets continue to rally back after steep selloffs.  Institutional, long term investors are allocating out of bonds into stocks.  We continue to believe this is a smart move.  Our strategy reflects this belief.