Anthony Mirhaydari
Our faith in stocks is fading.
Investors are fed up. We're tired of the volatility, the scares, the panics and the feeling that the deck is stacked against us. We worry about the economy, the financial system, the eurozone, the dollar and President Barack Obama or the Tea Party, depending on our political bent. We think the social fabric that binds us together is beginning to rip and fray.
No surprise, then, that after two painful bubble-and-bust cycles, people vow to never again be sucker-punched by the Wall Street fat cats.
The solution? For many, it is to run into the arms of Uncle Sam and the safety of Treasury bonds. Or, more recently, to keep their cash in the bank. According to new fund-flow data from research firm EPFR Global, investors have pulled nearly $153 billion out of U.S. large-cap equity funds since the bear market ended in March 2009, while sinking more than $55 billion into U.S. government bonds.
But that is the wrong strategy. Investors could be playing right into another bubble -- a bubble in fear and pessimism -- and setting themselves up for big losses as economic growth and inflation rebound, eating away at the value of their cash and bonds. Simply put, stocks are a safer bet right now than Uncle Sam's debt.
I'll explain why below, then offer a few low-risk recommendations to help people get back into the stock game.
Government is a mess; businesses are fine
Yes, there are real, structural problems with the economy, as I discussed last week in "The real recession never ended." But the fact is that stocks are now, by virtue of low valuations, underlying corporate strength and underappreciated inflation protection, are much more attractive long-term investments than are U.S. Treasury bonds.
Moreover, as I discussed earlier this month (in "This is not a 'Max Max' economy"), while the outlook has weakened, a new recession is still not likely.
That's because while the situation stinks for the average American worker and the government, it's been great for the average corporation. Just take a look at the graph above, which shows after-tax profits.
Profits are at record highs. Cash flows are surging. And balance sheets resemble Fort Knox, with debt levels falling and assets rising.
The reasons things stink for the average worker -- mainly, increased automation and competition from cheap foreign labor -- are the very reasons corporations are doing so well. Labor costs are the main expense for most businesses. Lower wages and smaller payrolls drop straight to the bottom line via wider profit margins. In addition, corporate revenue growth benefits from the ability to sell to fast-growing emerging-market economies, something the typical U.S. worker can't do.
On the other hand, the government is now the major source of weakness in the economy, with a deadlocked political system, out-of-control budget deficits, unfunded entitlements and rising debt burdens. Take a look at the chart above, which tracks the nation's debt as a percent of gross domestic product.
To put it another way, in the context of risk and debt, it's like this: The Office of Management and Budget estimates that the federal debt will grow from $14.7 trillion now to $20.8 trillion in 2016. That's up from around $9 trillion in 2008. At the same time, businesses and households continue to shed debt at an impressive pace. Deutsche Bank notes that household debt stands at the lowest level since 2005, while financial-sector debt has dropped back to 2002 levels.
(Households are essentially treading water, repaying debt burdens and enjoying some added spending power via ultralow interest rates, low debt service costs, and minor job gains. But that's a topic for another day.)
Put simply: The one area of the economy piling on risks and new debt -- the government -- is the area investors are flocking to for safety. I think that's a terrible idea.
