Waiting for the SPX Godot?

By Nikolay Stoykov, Managing Director, Alaric Securities

If anybody had asked me 12 months ago where do I think SPX will be in May 2020 if unemployment in the US, and most developed countries, is near 20% I probably would have laughed it off as a ridiculous question. However, if that person insisted, I probably would have said something like 1000 for SPX and 10000 for Dow Industrial.

On May 24 2019 SPX closed 2826 with unemployment at around 4% and on May 21 2020 SPX closed 2948 with unemployment at least 14% and probably closer to 20%, if expectations for May 2020 are to be taken into account. What is going on here, many people are asking – economic data is abysmal and expected to continue to be bad but markets seem oblivious and actually trading at a higher level than a year ago when economic data was actually quite good…

That is a very difficult question to answer as markets tend to move without giving us a clear explanation why but I believe that the answer/explanation lies in the interest rate environment we are facing. Let’s take a look at some historical comparisons:

In 2000, SPX dividend yield was around 1.1% with 30 year Treasury bonds trading at 5.8%.

In 2007, SPX dividend yield was around 1.9% with 30 year Treasury bonds trading at 4.6%

In May 2019, SPX dividend yield was around 1.9% with 30 year Treasury bonds trading at 3%.

In May 2020, SPX dividend yield was around 2% with 30 year Treasury bonds trading at 1.4%.

It is true that everybody expects the future dividend yield in SPX to be lower than the 12-month historical yield but even with a hefty drop of 30%, which is a lot worse than most expectations, SPX dividend yield will be still higher than the 30 year Treasury bond yield. From a historical perspective, unless there are waves of defaults and SPX dividends are cut by more than 50%, equity markets still offer quite good value relative to government bond yields.

Now with yields so low, I can not help but remember Alan Greenspan’s words – “People buying government bonds here are desirous for losing money” but they are still buying them… Anyway, all I am trying to say is that equity markets seem to be a lot more attractive investment than US government bonds.

In this low-interest rate environment, I feel like the Fed is pushing investors into risky assets and if there is anything I learned in 2009 is that one should not fight the Fed… Here is what I like:

• Equity Markets – broad cap ETFs like SPY or still distressed sectors like XLE or EEM
• High Yield Markets – HYG/JNK ETFs, still yielding nearly 7% with a 5-year maturity
• Hybrid Securities – PFF (preferred stock ETF), CWB (convertible bond ETF)

This is not a recommendation. The information provided is an objective and independent explanation of the matter. Alaric Securities OOD and other entities of the group do not trade in the above financial instruments.