What really ignites stocks
If you're looking for simple explanations of the long secular bull market cycle that began in 1982 and trying to predict when the next bull-market cycle will begin, I've got a simple set of numbers to show you.
In 1977, the yield on the U.S. 10-year Treasury bond was 7.61%; in 1978, 8.41%; in 1979, 9.43%; 1980, 11.43%; and 1981, 13.92%.
Interest rates peaked in 1981, with the federal funds rate hitting 20%, as the Paul Volcker Federal Reserve raised interest rates to punishing levels to break an inflation rate that had climbed to 13.3% in 1979.
In 1982, the yield on the U.S. 10-year Treasury bond was 13.01%. By 1989, it had fallen to 8.49%. By 1999, it was down to 5.65%. By 2009, it had fallen to 3.26%.
And you know what? Yields on Treasury bonds have continued to fall as global investors -- a class dominated by institutional investors, for what that's worth -- have looked to U.S. Treasurys for safety in the eurozone debt crisis. The yield on 10-year Treasurys declined from 3.26% in 2009 to 3.22% in 2010 to 2.78% in 2011.
Falling interest rates and falling inflation are the best explanations for the long secular bull market. Absent those two closely related factors, individual investors could have loved stocks or hated stocks and we wouldn't have seen the bull market that stretched to breaking when the subprime mortgage crisis hit in 2007.
Still no love for stocks
In the environment since 2007, exactly how irrational have individual investors been in their preference for bonds over stocks? That drop in Treasury yields -- courtesy of the turmoil in Europe -- powered the Barclays Capital U.S. 5-10 year Treasury bond index to a total return of 13.95% in 2011. The Standard & Poor's 500 Index ($INX), on the other hand, was up just 2.1% in 2011.
The index was up an additional 1.4% in 2012 through May 29 as U.S. 10-year yields have fallen to 1.75%. (Bond prices rise when yields fall, benefiting bond investors.)
I think it's hard, on the basis of those performance numbers, to argue that the preference of individual investors for bonds over stocks is anything other than rational. Certainly, individual investors who have been long bonds in the past 18 months or so -- a period when a number of very good professional money managers have moved out of U.S. Treasurys -- have been very happy with their choice. At least compared with stocks.
Of course, it's equally hard to argue that this preference for bonds will pay off as handsomely in the future as it has in the past -- even the very recent past. After all, there is no way -- no matter how much turmoil the European debt crisis creates for yields on U.S. 10-year Treasurys -- to duplicate the 12.75-percentage-point drop in yields from 1982 to May 2012 if yields are already at 1.75%.
But there's a big leap of logic to go from arguing that bonds will generate paltry -- and eventually negative -- returns to a conclusion that stocks are on the verge of a new secular bull market. Rising interest rates and rising inflation (a potential result of a depreciating dollar) aren't a recipe for a secular bull market, either.
Good news: We can still rally
Fortunately, you can have major rallies without a long-term secular bull market. During the secular bear market of the 1970s, for example, the Dow rallied 58% from May 1970 to January 1973 before giving back all those gains and more. From December 1974 to March 1976, the Dow rallied 74% before falling 26% from March 1976 to February 1978. (And I'd argue that we could still have one of those sharp rallies this year in an otherwise sideways market if investors are convinced that China's stimulus efforts will work. Take a look at the strong rally on Tuesday, May 29, on a belief that China was about to increase economic stimulus.)
Unfortunately, it seems you can't have major rallies without a long-term secular bull market and escape stomach-churning volatility.
This pattern is why I've been trying recently to sketch in medium-term trading strategies that will take advantage of this volatility.
Finally, I'd argue that the financial markets aren't made up of just two asset classes, bonds and stocks. There are assets -- dividend stocks, for example -- that blend some of the performance characteristics of bonds and stocks. There are some niche sectors -- biotechnology and shares of Apple (AAPL), for example -- that aren't closely correlated to the larger asset classes. There's real estate, of course, either directly or through a real-estate investment trust. And finally, there is the vague but increasingly popular class called "alternative." (I've been doing my homework on "alternative" investments recently, and I'll report on the topic not too far down the road.)
Updates to Jubak's Picks
These recent blog posts contain updates to the stocks in Jubak's market-beating portfolios:
- Are Spain's banks worth the risk?
- Copper mining drama boosts Freeport-McMoRan
- Why McDonald's still outdoes the competition
- Time to sell this oil-and-gas stock
- Weyerhaeuser will benefit from housing -- eventually
At the time of publication, Jim Jubak did not own shares of any company or fund mentioned in this column in his personal portfolio. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this column. The fund did own shares of Apple as of the end of March. Find a full list of the stocks in the fund as of the end of March here.
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Jim Jubak's column has run on MSN Money since 1997. He is the author of the book "The Jubak Picks," based on his market-beating Jubak's Picks portfolio; the writer of the Jubak's Picks blog; and the senior markets editor at MoneyShow.com. Get a free 60-day trial subscription to JAM, his premium investment letter, by using this code: MSN60 when you register at the Jubak Asset Management website.
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