The Worst Is Over, For Now

The Motley FoolIt would seem that the stock market rout of last week has ended – at least for the moment it appears to be over. Everything, for now, looks hunky-dory, again.

But what did you do during the stock market fallout? Were you, like many, gripped by doubt and uncertainty?

Did you wear a perplexed look as you licked the tops of your pencils, when you saw that the market value of some of your favourite shares had fallen below their intrinsic values? Did you question your own calculations? Or did you immediately whip out your cheque book and pen when you realised that stock prices were skewed in your favour?

Where did the money go?

Legendary investor, Seth Klarman, once said: “The stock market is a story of cycles and of the human behaviour that is responsible for overreactions in both directions“.

We saw the worst examples of human overreaction when money was being sucked out of emerging markets and relocated somewhere else. Precisely where that “somewhere else” might be, remains a mystery to me.

It didn’t go into the US stock market because American shares were down. It didn’t end up in the UK or European markets because they were also down. Japan’s stock market was firmly on the back foot, so we know the money didn’t go there. And China was closed for New Year celebrations, so it didn’t end up on the Shanghai exchange, either.

So where exactly did the money go?

It could have gone into bonds. But that would seem a little unlikely given the appallingly poor yields on fixed-income investments. It could have gone into property but that also seems questionable since real estate right now is hotter than the bottom of my laptop.

The rising cash mountain

So that just leaves cash as the remaining possible asset class that the money could have gone into. However, cash is a deeply unattractive asset class right now. It pays next to nothing in interest. Additionally, the real return is negative when inflation is factored in.

It is therefore unlikely that the proceeds of the snap share sale would remain as cash for any length of time.

There is something else to note too. America has not stopped printing money. It might reduce, over time, the amount of money that it will magic from within the Federal Reserve. But even at $65 billion a month, that still amounts to $780 billion a year to add to the trillions it has already created.

That might suggest the stock market bull-run could still have some distance to go.

Legendary investor Peter Lynch once said: “When yields on long-term government bonds exceed the dividend yield of the S&P 500 by 6% or more, sell your stocks and buy bonds“.

Do gentlemen really prefer bonds?

Although I don’t go a whole bunch on tactical asset allocation, I can appreciate the message that Peter Lynch is trying to convey. In fact, it is not too dissimilar to Warren Buffett’s well-worn quip about fear and greed: “Be greedy when the market is fearful, be fearful when the market is greedy“.

Currently, US 10-Year Treasuries are yielding 2.7% while the dividend yield on the S&P 500 is around 2%. Closer to home, the Straits Times Index (SGX: ^STI) is yielding around 3%, while the Government 10-Year Bond yields 2.4%. That might change but it is unlikely to change any time soon. The point is this: the continuing penchant for safe-haven bonds, which is depressing bond yields, would suggest that the stock market remains the more attractive investment option.

Using Lynch’s yardstick, we could still be some distance away from seeing bond yields surpass dividend yields by 6% or more. Or as Peter Lynch once said: “Gentlemen who prefer bonds don’t know what they are missing“.

This article first appeared in Take Stock Singapore.

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