The Great Interest Rate Differential explains what is driving the biggest bull market ever in stocks.
So, do you know why the stock market keeps setting new highs during a global pandemic?
Then how can this be? Business are forced to close. Populations are locked down. Bankruptcies are at an all time high. Yet stocks continue to soar!
With this in mind, the following concepts are very important:
First thing to remember is inflation is the enemy. That is to say investors seek to generate a return greater than inflation.
To illustrate, today a US 10-year treasury note yields 1.04%. According to the St. Louis Federal Reserve the inflation rate is 1.81%.
So, you have all the information at your finger tips to calculate your real rate of return.
Real Return = Nominal Return – Inflation
Accordingly, the real rate of return is negative -0.77%. In fact, investing in US treasuries is a bad idea. Terrible!
What about corporate bonds? Do they offer a better return?
Unfortunately, the corporate bond space provides only a mild improvement. As I write this post the corporate bond yield is 2.28%, meaning a real return of +0.47%. Hardly a return to get excited about!
What about dividends? Do they provide any hope to investors?
To explain, let’s look at Verizon Communications (VZ – NYSE). Its dividend yield is approximately 4.23%. Taking inflation into account the real return is +2.42%!
That’s over 400% higher than corporate bond yields!
However, we must consider the relative risk of these investments – US treasuries, corporate bond and dividend stocks.
Unfortunately, zero interest rates (and other Federal Reserve policies) have altered what the meaning of risk is. In fact, US treasuries are still considered risk free by the academic community.
Conclusion
In a word, zero interest rates are behind the biggest stock bull market in history. Equally important, Wall Street and foreign investors can’t get out of the bond market fast enough.
To sum up, money is rapidly leaving the treasury and bond markets for the stock market. Indeed, savvy investors understand the devastation caused by inflation and are taking appropriate actions.
Are you?
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