Alaric Securities celebrates at Nasdaq MarketSite
May 22, 2020

Waiting for the SPX Godot?

Alaric Securities

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.

US Unemployment Rate April May 2020

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.