Risk is back, and world stock markets fly higher. For those investors having the courage to stick to their convictions, the wait may be worth it.
I left you yesterday by saying the stock market felt neither too hot, nor too cold, but just about right.
Well, yesterday's action both here in London and over on Wall Street made my prediction already look out of date, with markets rising over 1% across the board. We even had a good old fashioned mega-takeover offer, with BHP Billiton (LSE: BLT) bidding $39 billion bid for fertiliser giant Potash Corp. of Saskatchewan.
As long-term investors will know, one day's action doesn't make a summer, let alone a year, a decade or a lifetime. Still, the day to day movements are fun to watch, and even more fun when they give you periodic compelling buy opportunities.
And what a difference a day can make. Over the past few weeks, the market has been fearful of the dreaded economic double-dip recession. The US economy in particular has been under the microscope, with a still slow housing market and still high unemployment leading the Federal Reserve to say just a few days ago "The pace of economic recovery is likely to be more modest in the near term than had been anticipated."
Risk Is Back
Fast forward to today, and suddenly investors are again willing to embrace risk. And in this context, risk means eschewing gilts, bonds and treasuries, and embracing equities.
On that note, earlier this week, JP Morgan Chase said…
"People would rather overpay for bonds than underpay for stocks. It's a reflection of an extraordinary prejudice. If people are at an emotional extreme, it means that at some point there's got to be reallocation of cash away from the bond market toward the stock market. Ultimately, it's bullish."
Perhaps yesterday, people woke up, smelt the coffee, decided the chance of a double dip recession is relatively small, looked at the yield on 5-year gilts of 1.8%, and decided to take JP Morgan's advice, and buy shares.
Cheap Stocks
Certainly the pundits on Bloomberg were bullish.
"Stocks look cheap. Earnings look really good. The consumer is in better shape than the headlines would suggest. Corporations are flush with cash and it's cheaper to buy assets than to build them. There's not a whole lot of downside for stocks. We may challenge the highs for the year."
FTSE 6,000 here we come? Maybe. More from Bloomberg…
"There will be a continuing bull market."
And…
"Equities are no longer overvalued, as they were at the start of the year. Given the rapid decline in government bond yields, based on trend earnings this signal is suggesting a switch from bonds to equities."
Maynard Paton, chief analyst at our Champion Shares PRO newsletter, is well known in the Fool office for demanding low valuations before he'll invest. But even he sees some value in the market right now. He told me:
"Certainly now is not a bad time to back the market with the FTSE trading around 5,300 and offering a 3.4% yield. Remember, the market's income ought to improve, too, if the likes of Vodafone (LSE: VOD) stick to its progressive dividend plans and BP (LSE: BP) can re-start its payouts."
It's Time To Switch
The switch trade is seemingly on, for the moment anyway. Switch from bonds to shares. Traders, those people behind the faceless computers that dominate the day to day movement of markets, love the switch trade. They go wherever the money is, and yesterday it was out of bonds and into shares.
For normal investors like you and I, switching in and out of bonds is a one-way trade to the poor farm. The chances are you won't get your timing right, and if you happen to be in the wrong asset class at the wrong time, you'll potentially miss out on big gains, like those that equity markets saw yesterday.
Stay The Course
Instead, have the courage to stick to your convictions, and stay the course. The course we like to talk about here at the Motley Fool is a lifetime course, so you've got plenty of time to be right with your convictions.
For me, for some time, my conviction has been in cheap, high yielding blue chip shares. When you compare the earnings yields on offer (10%) and the dividend yields on offer (5%) to the yields on offer on 5-year gilts (1.8%), the decision looks a no brainer.
JP Morgan Chase agree. Legendary US investor Bill Miller agrees.
The bears will continue to point to deflation, and the near certainty of a double dip recession.
Thank You, Bears
God Bless the bears. All that fear. All that worrying. All those predictions of FTSE 3,000. Thank you.
In the face of such compelling reasons to buy shares, their "extraordinary prejudice" is keeping share prices low… for now anyway.
More on the economy and the markets:
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> Bruce owns shares in BP.
