Effects of Demographic Shift and Baby Boomers

[Dan Amerman]

Re: Effects of Demographic Shift and Baby Boomers

It sure can reverse, Dan! ;) Now the question of when is another matter altogether. My take is that for the time being inflation is too high for that. People now demand bond 'dividend' yields twice as high as stocks as compensation for the risk that the future value of those yields will be eroded by inflation. There is always risk, the nature of that risk is at issue.

It is good to come closer to agreement, Finster!

To discuss further, however, I don't think bond yields or dividend yields have had much to do with classic economics in these early years of the 21st century. Bond yields remain irrationally low compared to the inflation we have because of the two way combination of the central banks keeping investment banks flooded with liquidity, and countries such as China using Treasury purchases to prop up the dollar as they grow their own economy.

Incidentally, am I correct that you were implying that bond and dividend yields could return to a more normal relationship through bond yields coming down? That is only one alternative, call it the bull market alternative. The alternative scenario, is stock dividend yields skyrocketing, as the result of some most unfortunate price movements...

[bart]

Re: Effects of Demographic Shift and Baby Boomers

That is only one alternative, call it the bull market alternative. The alternative scenario, is stock dividend yields skyrocketing, as the result of some most unfortunate price movements...

And another alternative is a milder version of Weimar:

[Finster]

Re: Effects of Demographic Shift and Baby Boomers

It is good to come closer to agreement, Finster!

To discuss further, however, I don't think bond yields or dividend yields have had much to do with classic economics in these early years of the 21st century. Bond yields remain irrationally low compared to the inflation we have because of the two way combination of the central banks keeping investment banks flooded with liquidity, and countries such as China using Treasury purchases to prop up the dollar as they grow their own economy.

Incidentally, am I correct that you were implying that bond and dividend yields could return to a more normal relationship through bond yields coming down? That is only one alternative, call it the bull market alternative. The alternative scenario, is stock dividend yields skyrocketing, as the result of some most unfortunate price movements...

Your point about yields being depressed due to the current liquidity flush is well taken. Paradoxically, the inflationary posture of the Fed over the past few years has actually been depressing bond yields since all that cash has to find a home somewhere, and the bond market is big and liquid enough to accommodate a lot of it.

The inflationary influence of the Fed since 1933, I believe, is largely the impetus behind the relative low level of stock yields as compared to bond yields. Remember that stock yields are conventionally quoted in terms of current yield, which has generally been less that actual prospective yield due to the ability of stock dividends to rise with inflation. Most bonds don't offer that. Prior to more or less permanent institutionalized inflation, the the upside and downside risks to stock dividends were more equal. Investors demanded higher yields as compensation. But over the course of thirty years or so of pervasive inflation, investors learned that real bond returns were very inferior due to the inflation risk inherent in fixed income, and the equity premium inverted.

So as long as we have prospects for permanent inflation, it's likely that the central tendency will continue to be for lower relative stock yields. This is relative, of course; the yield gap will continue to rise and fall, and it is possible that stock yields could nose above bond yields now and again. But long term, I suspect stock yields will generally be less than those on bonds.

It's difficult to say exactly what the equilibrium point is at any given time. If it were, I guess, investing would be a lot easier than it is! But my analysis suggests that at the present time, given the inflatonary environment, bond yields are actually low relative to stock yields. Put another way, bonds are more overvalued than stocks.

I can only speculate as to why, but would guess that it has to do with the backwash from our trade deficit. Most of our excess money production winds up in places like Asia, and when it comes back to the US, it tends to be via the bond market. You've alluded to this yourself.

Because we choose our investments from a finite menu, it is not sufficient to simply posit that stocks are overvalued and therefore eschew all stock exposure. In some sense, stocks can be overvalued, but if the principal alternative, bonds, are even more so, you nevertheless have a good case for having some stock! The so-called "alternative" asset classes, including real estate and commodities, I believe have been in bull markets due to the overvaluation in financial assets pursuant to persistent inflation. As a result, overall, I'm overweight commodities, underweight bonds, and just slightly underweight equities.