Next Bubble: Corporate
Bonds...or Stocks
Tulip bulbs, Florida real estate, The Nifty Fifty, Gold,
Japanese real estate, The internet, Housing ‒ history is
littered with asset bubbles where investors piled into the
next hot thing, only to lose much or all of their investments
once the bubble bursts.
A leading strategist said the next bubble could be in
something more mundane ‒ high-quality corporate bonds ‒ as
investors, burned after US stocks fell by half from late 2007
to early 2009, flock to perceived safety.
And then, perhaps down the road, it could be the turn of
some equities to become overheated again. "Retail investors
buying bonds today, at a time when the supply of corporate
bonds is shrinking... they're chasing a bubble," Tom Lee,
chief US equity strategist at JPMorgan Chase & Co, said
Wednesday at the Reuters Investment Outlook summit in New
York. "We had a credit bubble, a mortgage and housing bubble,
and that caused equities to collapse," Lee said. "I wouldn't
rule out equities as the next area where bubbles could emerge,
but I don't think it's going to start in 2010."
Many speakers at the Reuters Investment Summit have
said individual investors remain cautious on stocks, despite
a 13-month run-up that ended in April, saying net US
domestic stock fund inflows have been roughly nil.
In contrast, bonds are attracting bushels of cash.
The intermediate-term bond fund Pimco Total Return
PTTRX.O, the world's largest mutual fund, has some US$227.9
billion of assets, according to Morningstar Inc. And the
average high-quality corporate bond yields 4.5 per cent, a
level last seen in 2004.
The love for bonds might not last, Lee said. "Have
Americans ever been satisfied with earning a steady rate of
return?" he said. "What we have in American history, I think
in capitalism, is rolling bubbles, whether it's real estate,
commodities, land speculation, emerging markets, time
shares...Basically, savers chase the next bubble, and then
when that bubble shifts, they will move to the next one."
"No Brainer" for
Stocks
Lee said prices on 10-year Treasuries and high-grade
corporate bonds appear rich relative to the price-earnings
ratio of companies in the Standard & Poor's 500 .SPX.
Treasuries trade at about a 33 multiple, or the number of
years it takes to earn $1 from $1 of principal, while
corporate bonds trade around a 20 multiple, he said. But more
than half the S&P 500 stocks trade below a 10 multiple, he
added.
"Corporate balance sheets are pristine today, so the
bond multiples are justified," Lee said. "But the equity
multiples are ridiculously low." Lee noted that the average
yield on corporate bonds is just 2 percentage points higher
than the S&P 500 dividend yield, the smallest differential
since 1967.
"Corporate bonds are already trading at 108" cents on
the dollar, Lee said. "If they were at 130, what would you do
if you were General Mills? Buy back all your bonds, and issue
new bonds at 3 per cent. And then what does it mean for
your stock? All of a sudden, maybe you de-equitise by 30 per
cent, because your cost of capital can justify it."
General Mills bonds have risen in price. Its 5.65 per cent
notes maturing in 2019, sold in January 2009 at US$0.9991 on
the dollar, traded Wednesday at US$1.1176, and yielded 4.03
per cent, according to the bond pricing service Trace.
Kirstie Foster, a spokeswoman for the cereal maker,
declined to comment, citing a "quiet period" before General
Mills reports quarterly results.
Lee said improved corporate credit quality historically
heralds increasing stock prices and could do so again. He
expects the S&P 500 index to rise roughly 20 per cent by
year end to about 1,300, saying it could easily support a
price-earnings multiple above 14, compared with about 12 now.
"I think you get the no-brainer to buy stocks for the next
decade, unless you just thought we were going to have the
world economy shrink," he said. "Or if we're Japan."