The Money Trap — Why Investment Money Has Nowhere to Turn

Investment money has a tendency to run to the place where it has the potential for the highest return.

In the late 1990s, we saw investment money run into tech stocks as the NASDAQ hit 5,000 (only at 2,209 today, 10 years later). In the mid-2000s, we saw money run to real estate as property prices boomed on interest rates that were low and easy-lending policies (residential property prices have fallen about 30% since then).

When the Great Recession hit, “money” got scared and ran to the safety of U.S. Treasuries. But with so much money chasing T-bills, bond yields fell to their lowest rate of return on record. Money isn’t running to gold yet, because most investors have yet to realize there is a bull market in gold bullion prices (but this will eventually happen, propelling gold prices much higher than they are today).

By our estimates, the stocks that make up the Dow Jones Industrial Average will collectively pay $280.00 in dividends this year. Based on yesterday’s close, the Dow Jones Industrial Average is yielding 2.7%.

Compare the 2.7% dividend yield of the Dow Jones Industrial Average to the three-month U.S. T-bill yield of 0.15%, or the three-year U.S. T-bill yield of 0.77%, or even the five-year U.S. T-bill yield of only 1.42%, and suddenly stocks do not look expensive.

Historically, bull markets have ended when the dividend yield on stocks has fallen below three percent and bear markets have ended when stock dividend yields have hit six percent. However, we must realize and acknowledge that these old guidelines were based on normal interest rates. A Federal Funds Rate of zero and 30-day Treasury rate of 0.15% are far from normal.

If we look specifically to return on money, stocks today, based on dividend yields alone, offer investors the biggest bang for their buck. As the U.S. economy continues to improve, as we understand that high unemployment and low residential housing prices are here to stay for years, and the fear of such turns into acceptance of “the way it is,” the yields on stocks will look more and more attractive.

Stock market advisors in 2010, several of whom are calling for stocks to crash, are failing to look at the various returns on money investors have available to them. Stock dividends yields today, compared to the yields on other forms of investment, are offering support and value for stock prices.

Michael’s Personal Notes:

The second quarter of this year marked a very significant point in world economic history: in the second quarter, China surpassed Japan as the world’s second largest economy.

China’s gross domestic product in the second quarter of 2010 came in at $1.34 trillion. U.S. GDP is about $3.5 trillion a quarter. China was already the world’s largest automobile market and the world’s biggest exporter.

A report from Price Waterhouse Coopers says that China will take over from the U.S. as the world’s largest economy by the year 2020. Goldman Sachs believes will happen in 2027.

But does the timing really mean anything? No. The fact is that we will see the U.S. dethroned as the world’s biggest economy in the short years ahead. For almost a decade now, I have been writing about the importance of investor portfolio exposure to the growth in China. It’s not too late to seriously consider diversifying your portfolio to ensure you participate and benefit from the unprecedented growth in China.

Where the Market Stands:

Yesterday, the Dow Jones Industrial Average turned just about breakeven for 2010. The market is in a narrow trading range. While most of the old big-name advisors are very bearish on stocks, I continue to believe that we are in a bear market rally that started in March 2009 and that the rally still has more time to run.

What He Said:

“The Dow Jones Industrial Average, the S&P 500 and the other major stock market indices finished yesterday with the best two-day showing since 2002. I’m looking at the market rally of the past two days as a classic stock market bear trap. As the economy gets closer to contraction, 2008 will likely be a most challenging economic year for Americans.” Michael Lombardi in PROFIT CONFIDENTIAL, November 29, 2007. The Dow Jones Industrial peaked at 14,279 in October 2007. A “suckers” rally developed in November 2007 which Michael quickly classified as bear trap for his readers. By mid-November 2008, the Dow Jones Industrial Average was at 8,726.