Friday, May 11, 2012

In Search of a One-Handed Market

Former U.S. President Harry Truman famously used to say that he wished he could find a one-handed economist.

Truman was frustrated by the fact that he never seemed to be able to get a definite answer on the issues of the day from his economics team.

Whenever he would ask for an opinion, Truman related, he would inevitably get a response that started with "Well, on one hand" but then shortly followed with a completely different opinion that started with "Of course, on the other hand".

Hence Truman's desire for a one-handed economist.

If Harry Truman was investing into today's economic climate, he too might be frustrated by the lack of a cohesive economic pattern.

For example, government bond yields in "safe haven" countries like the U.S., Germany and the U.K. are approaching record lows. 

So investors are worried, right?

Well, maybe, but why are corporate bond yields also approaching record lows.  Investors are not only gobbling up bonds from high grade issuers like IBM but also riskier credits as well.  Ford, for example, was able to borrow 3-year money at 3% earlier this week, despite the fact that its credit rating remains below investment grade.

Then there's more:  earnings estimates for companies are gradually being moved higher after first quarter results for not only U.S. companies but European corporations as well.

Yet global analyst Michael Hartnett at Merrill Lynch wrote this morning that (I have added the emphasis):

European equities as cheap versus German bonds in almost 90 years.  The spread between European equity dividend yield (4.29%) and German 10-year government bond yield (1.52%) was 277 basis points.  This yield spread has been surpassed only once (303 bps in February 2009) since 1925.

German bond yields are at lower levels today than during the depression of the 1930's. Indicates Europe very oversold. As does the price relative between European and U.S. equities, which is trading 3 standard deviations below norm.

Finally, consider the price of gold.

Gold prices have plunged by -15% since reaching a peak last September, and now stand at roughly the same level as a year ago.  Someone who had heeded the advice of the gloom-and-doom crowd last fall and bought gold rather than stocks would have suffered a relative return shortfall of nearly -30%.

So if we are approaching financial Armageddon - as many pundits are suggesting - why is gold (the ultimate safe haven) losing value?