Monday, August 27, 2012

Has "worship of stocks" turned into "reverence for bonds"?

The trend started in early 2009. Net flows into fixed income mutual funds began to rise, while equity funds stayed flat. The trend continues through today, although equity ETFs have fared better than mutual funds (see discussion). But even within the ETF universe, flows into fixed income accelerated while equity ETFs grew quite gradually if at all.

Shares outstanding for SPY (S&P500 ETF)  vs LQD (investment grade bond ETF) (Bloomberg).

Given that the corporate bond market is smaller and less liquid than the equity market, that imbalance in growth of cumulative flows has driven yields/spreads to historical lows. Now some analysts are asking if corporate credit is overpriced relative to equities. One way to assess this is by looking at corporate bond yields vs. equity dividend yields.

The spread between the two has collapsed recently. One gets almost the same income holding corporate bonds as buying the S&P500 stocks. Is this the "new normal" according to PIMCO? Has the "worship of stocks" turned into the "reverence for bonds" (which is of course what Bill Gross wants)? Or are we simply looking at a market dislocation?

Source: CS
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