Are stocks in for a sea change?

Bond yields will begin to rise as the economy improves, destroying bond values and ushering in a nasty bear market.

By Forbes Digital Nov 14, 2013 12:35PM
Image: Stock market (© Zurbar/age fotostock)By David Dreman, Forbes Contributor

Things couldn’t have been rosier for equities in 2013.

As I write this, stocks are up 187% from the depths of the crisis-panicked stock market of March 2009, and this year stocks are already up 24%.

It’s been a banner year except for those holding bonds. The 30-year Treasury, by contrast, is down 11% from January 2013.

Is this finally the end of the great bond bull market? The Fed, along with almost all industrial nations, has printed enormous amounts of currency to finance deficits. Our deficit has risen 67% in the past five years to almost $17 trillion. And this doesn’t consider the Fed’s quantitative easing programs, which put us in an even deeper hole.

I won’t bash Bernanke or his easy-money legacy. His money flood helped save our financial system. But the Fed has been easing far too long, and millions of retired investors are paying a frightful price in paltry returns on their savings. Moreover, millions of employees now have their retirement accounts badly underfunded.

Even though the Fed has not cut back on its purchases of Treasury and mortgage bonds, many folks fear that a tapering-down policy will cause the economy to slide back into a downturn. Both the Fed and major central banks appear to be trapped.

So where to now? If rates move up over time, as appears likely, holding mid- or long-term bonds will be calamitous. As the economy improves in the next few years, yields will begin to rise at a faster rate, destroying bond values. This could bring on a nasty bear market. In a worst-case scenario I see inflation climbing to 10%, as it did from 1978 to 1982. Back then long bonds yielded as much as 15%, while short Treasurys reached almost 20%.

Why are big institutional investors and bond experts ignoring this enormous danger? It’s textbook investor psychology. Investors tend to fixate on the present and recent past, and time and time again extrapolate these trends well into the future.

Don’t despair: After the initial shock of rising inflation and interest rates, the market will resume its climb. That’s precisely what happened from 1978 to 1982 when stocks climbed 14% annually, beating the rate of inflation by four percentage points. If I’m right on inflation and rates, we’re on the cusp of a major bull market move.

Like Warren Buffett, I’m not a gold bug and prefer real estate and equities as inflation plays. Here are some good stocks for the next market wave:

ConocoPhillips (COP) is one of the world’s largest independent oil-and-gas exploration companies. It’s in a transition period, selling assets with so-so returns and putting the proceeds into other projects. Earnings are expected to be up almost 10% this year and again in 2014. The stock trades at a P/E of 14 and has a dividend of 3.8%.

Freeport-McMoRan Copper & Gold (FCX) has been badly hit, dropping over 10% from its 2012 high. It trades at a discount of 10% to its global mining peers because of its large stakes in copper and gold. Now that it’s made several acquisitions in oil and gas, earnings are expected to rebound by 21% for 2014. FCX has a P/E of 13 and yields 3.4%.

The worst is behind global banking giant JPMorgan Chase (JPM). I think it will show a 13% increase in earnings in 2014, despite slow loan growth and some near-term pressure on margins. Its P/E is 12, it yields 2.9% and it’s trading at a 60% discount to the book value of the S&P 500.

Office supply giant Staples (SPLS) has gone through a rough patch trying to downsize U.S. stores while at the same time taking its model to Europe. I expect earnings to rebound strongly. Staples has a forward multiple of 11 and yields 3%.

Larry Ellison’s software company Oracle (ORCL) has had an impressive growth rate for several decades. It could get even better with its aggressive new stock buyback program. Oracle provides good value at an estimated 2014 P/E of 11 and a yield of 1.4%.

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12Comments
Nov 14, 2013 2:01PM
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The Best is yet to come !!!   Dow at 18-19K will probably be considered as normal 12/31/16.
Nov 14, 2013 6:56PM
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The article starts off good then drifts away as he never really drives the point home that the middle class and pension holders are going to get killed when the bond market explodes. He claims wall street will continue to rise and inflation will increase 10% over time. What does that mean for the average American, less purchasing power less savings and deeper debt. Wow that sounds great. Oh and by the way how does the gov't plan on paying back 17 trillion $ it owes? It's not, either they default or inflate the dollar away.  Both are no good for middle America. This is without a doubt the worst economy we have ever had and it is all based on debt.
Nov 14, 2013 5:19PM
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Good, well run companies normally weather the storm and make it to Port with the bounty.
Nov 14, 2013 7:17PM
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What other games are in the town ??
Nov 15, 2013 1:36PM
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You have to wonder about the credibility of an author when they mix up deficit with debt.
Nov 14, 2013 7:49PM
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I agree exceo, I am putting 16% of my gross in my 401K, and whatever col raise I get. Presently I have at least a 3X higher balance than most of my co-workers. Never take out a loan unless you HAVE too, invest wisely, and sink every dime you can afford into it. Right now I am at 6 figures and climbing, enjoying the ride!! 
Nov 14, 2013 3:57PM
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You betcha!!!! Banner year based on toilet paper Benny Bucks with no connection whatsoever to reality!!  That's where I'm putting MY money!!! Woo Hoo!!!!
Nov 14, 2013 3:40PM
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Watch out Asia is going to kick the US's butt!
Nov 14, 2013 4:23PM
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His money flood helped save our financial system.

Sure. The Wall Street "capitalists" who are really lazy, welfare, freeloading leeches, have become 4 times richer since 2008 because of his hand-outs, and 50% of the middle class American people are still stupid to keep believing in capitalism. Capitalism has destroyed the middle class, and America in general, and these stupid middle class "capitalists" deserve they get,.. layoffs, outsourcing,etc.

Socialism is the way out for the middle class.

You cannot have Capitalism, and your job at the same time. Choose.

If you say you are a capitalist, and you lose your job, then you should be happy, since losing your job is part of capitalism.

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