The Best Stock Market Buy Signal In 51 Years
by Alexander Green, Chairman, Investment U
Investment Director, The Oxford Club
Monday, January 5, 2009
Media pundits keep reminding us how tough 2009 will be economically. Nevertheless, I predict this will be a good year for the stock market.
How can this be?
The stock market is a leading indicator. It generally falls before consumers and investors realize just how bad the economy is.
It also recovers long before economic activity picks up. Perversely, that means stocks often plummet during good economic times and rally during recessions… or worse.
In the January issue of The Oxford Club Communiqué, for example, I note that:
- In the 13-month recession in 1926-27, the market went up 41.1%.
- In the eight-month recession in 1945, it went up 19.5%. In the 11-month recession in 1948-49, it went up 15.2%.
- In the 10-month recession in 1953-54, the stock market went up 24.2%.
- In the 10-month recession of 1960-61, it went up 20.3%.
- In the 16-month recession in 1981-32, the market went up 14.6%.
- And so on.
The stock market doesn’t always rise during a recession, of course. And right now is particularly tricky because there is simply no precedent to today’s economic mess. We’ve never seen a real estate/mortgage crisis create a meltdown in the credit markets this way. Nor have we seen the Federal Reserve take such extreme measures to set things right.
However, investors can take some reassurance from one of the best – and most accurate – buy signals in the stock market. Here’s how it works…
20th Century Investing – Buying High-Yielding Stocks
Investors in the first half of the 20th century found that if you did nothing more than buy stocks when their yield exceeded the yield on Treasuries – and sell them when the yield on Treasuries exceeded the yield on stocks – you would have been in for every major rally and out for every major correction.
The returns were huge – and the system made sense. Stocks are riskier than bonds, market participants reasoned, so they should yield more to compensate for greater volatility and the likelihood of occasional losses.
The system worked like a charm until 1958. Then stopped cold. Stocks never yielded more than Treasuries for the next 50 years.
Public companies began using their cash flow to fund operations and acquisitions rather than paying out dividends to shareholders. With stock yields sharply lower, most analysts reasoned that the indicator was dead, that the yield on stocks would never again top bonds.
But after more than five decades, they have…
The S&P Yields More Than Treasuries For The First Time In 51 Years
Beginning on October 13, the 3.74% yield on the S&P 500 exceeded the yield on the 10-year Treasury for the first time since 1958.
If history is any guide, that means stocks are an excellent long-term buy and Treasuries – which have become a complete bubble (and table-pounding sell) in my estimation – are due for a long period of relative underperformance.
Don’t get me wrong. U.S. economic growth is likely to be negative over the next 12 months. But – shocking and surprising most investors – stocks should do well. And high-dividend paying stocks – especially those outside the troubled financial sector – may perform best of all.
One caveat, however. When focusing on yield, buy only healthy dividend-paying companies – those with rising sales and earnings – and reinvest those dividends for maximum total returns.
I’ll be highlighting many of these companies in the Communiqué in the weeks ahead.
Good investing,
Alex
