I'm always looking for a buy signal for stocks. In my opinion, one of the best buy signals for stocks is when the S&P 500 yield is greater than the 10-year Treasury bond yield. At the time of this update, this buy signal is flashing green.
The reason why I prefer owning real estate and starting a business is that I can do things to help improve my chances that the assets will perform.
With Financial Samurai, there's a strong correlation between the number of articles written and the amount of traffic the site receives. I can spend more time building rapport with readers. I can also write guest posts on other sites to widen Financial Samurai's reach.
With a real estate investment, I can paint the interior and exterior, refinish the floors, change the fixtures, landscape the front and back yards, expand the livable space, keep up with market rents, find higher-paying tenants and so forth. Then when rates get low enough, I can refinance my mortgage to improve my cash flow.
But with stocks, you and I are minority investors with no say. We are at the mercy of exogenous and endogenous variables. Maybe a CEO will be found guilty of embezzlement. Maybe there will be some type of data breach. Or maybe Amazon or Google will announce they are entering your space.
Yet, investing in the S&P 500 over the long term has proven to be one of the best ways to build a fortune as well. Therefore, all of us should have some exposure to the S&P 500. It's the amount of exposure that is up to all of us to decide.
A Buy Signal For Stocks
We've discussed the importance of taking advantage of arbitrage opportunities in a previous post. There are kinks in the system that can be exploited every day.
If you've got cash lying around, it's a no-brainer to take advantage of online savings rates that are way higher than the current 10-year bond yield. I'm not going to leave any cash in my main transaction bank, Citibank, because they are only paying me a savings rate of 0.04%. Pathetic!
But what if you want to take more risk because you're willing to lose money in order to potentially gain more money? The S&P 500 is one of the easiest risk asset for anyone to buy. We know that the S&P 500 has provided a 5.6% compound annual return between 1999 – 2018, and close to a 10% compound annual return from 1926 – 2016.
There is one indicator that has historically shown to be a buy signal for S&P 500 bulls: when the S&P 500 yield is higher than the 10-year bond yield. This unusual occurrence happened recently.
Given the S&P 500 has historically outperformed the 10-year Treasury bond in terms of principal appreciation, investors start to get interested when the S&P 500 yield alone is higher than the 10-year Treasury bond.
When The S&P 500 Yield Is Higher
An S&P 500 investor can view the yield as either a bonus or a buffer. For example, if the S&P 500 appreciates by 10% and you also get a 1.5% yield for an 11.5% total return, you can view the yield as a bonus.
If the S&P 500 declines by 10% and you get a 1.5% yield for a total negative return of 8.5%, you can view the yield as a buffer. Your view depends on the direction of the market, your general disposition, and your risk tolerance.
Right now is tricky because the S&P 500 is close to an all-time high, the yield curve has inverted, yet the S&P 500 yield was recently higher than the 10-year yield as of September 2019.
Do you view the yield as a bonus or as a buffer? Given I'm a conservative investor who doesn't want to go back to full-time work, I view the S&P 500 yield more like a buffer in case of a pullback.
What Happened With The Buy Signal During The Last Crisis?
During the 2009 financial crisis, the 10-year bond yield collapsed as investors sought the safety of bonds. But notice how the S&P 500 dividend yield soared as the S&P 500 crashed because companies were late to cutting their dividend payouts.
If a rise in the S&P 500 yield is seen as an ominous sign for equities, then S&P 500 bulls should find solace in today's S&P 500 yield data that shows a steady 1.5% – 2.1% yield since 2010. The hope is that companies this time around are more proactive with their cash reserves instead of reactive.
At the same time, a 10-year bond yield below the S&P 500 yield makes the S&P 500 incrementally more attractive. What is an S&P 500 investor supposed to do? An investor would have done spectacularly well if they had bought in 2009.
Based on the analysis by Renaissance Macro Research (RenMac), the Sharpe Ratio is 100% higher and the annualized return is 68% higher when using yields as a buy/sell signal for stocks versus bonds.
In other words, the data is showing that when the S&P 500 yield is higher than the 10-year bond yield, one should be an incremental buyer of the S&P 500 index.
Do You Believe In The Buy Signal?
As you can tell from the S&P 500 / 10-year bond yield analysis, it's not as straight forward as saying, “Buy panoramic ocean view properties in San Francisco because they are irrationally trading at a discount to the median-priced property, whereas panoramic ocean view properties in other major cities trade at tremendous premiums.“
Real estate is so much easier to understand, which is why for most people, I think real estate is the better want to build long-term wealth.
The argument to buy the S&P 500 at all-time highs, despite its yield being higher than the 10-year bond yield, is much more nuanced because there are so many more tea leaves to read.
The very next day, the 10-year bond yield could be way higher than the S&P 500 yield. Then what? Sell all stocks and build a bunker, especially since the S&P 500 is way above trend?
To finalize the arbitrage trade, some investors would say one should short the 10-year Treasury bond given there could be a reversion to the mean. Based on the first chart, very rarely does the 10-year bond yield stay below the S&P 500 yield for very long.
Stocks Usually Go Up Over The Long Run
Despite the murkiness of the S&P 500 yield versus 10-year bond yield indicator, it is comforting for stock investors to know that rational money will start slowly shifting out of bonds and into stocks due to the relative value the S&P 500 now provides.
All we really know for certain is that the S&P 500 has provided investors a positive return over the long run. Therefore, we should all have some type of exposure and continue to dollar-cost-average over the long run.
Finally, as an investor, please be aware of your biases. You will ultimately find evidence to support your bullish or bearish stance. It's important to always see the other side of the trade.
The buy signal for stocks is currently indicating investors should get long. With the Fed committing to keep interest rates low, investors have “no choice” but to invest in riskier assets like stocks and real state going forward.
The Yield Curve Today
Post pandemic, the yield curve is now upward sloping and relatively steep. The Fed slashed rates to 0% – 0.25% and long-bond yields have risen from their 2020 pandemic lows. As a result, there is a very bullish feeling in the air.
I'm personally very positive on the housing market and am investing as much as possible in the space. I believe the mortgage rates will stay low for a long time, even though they are up from 2020. The economy is recovering, wages are growing, and corporate earnings are rebounding aggressively.
Refinance your mortgage ASAP: The 10-year bond yield has fallen to all-time lows. Check out Credible, my favorite mortgage marketplace where prequalified lenders compete for your business. You can get competitive, real quotes in under three minutes after filling out an application. NMLS ID# 1681276, Address: 320 Blackwell St. Ste 200, Durham, NC, 27701
Invest in real estate: With interest rates collapsing, affordability and demand is increasing for real estate. Check out Fundrise, my favorite real estate crowdfunding marketplace where you can invest in real estate all around the country for as little as $500. Fundrise is free to sign up and explore.
Disinterested in reading the tea leaves? Check out Betterment, the #1 low-cost digital wealth advisor today. They will create and manage an investment portfolio based off your risk tolerance. All you've got to do is answer some questions and regularly contribute to build your portfolio in a risk-adjusted way.
The 10-year bond yield has inched back over 1.6% thanks to higher inflation expectations. The economic stimulus has been tremendous since the pandemic began. However, 1.6% on the 10-year bond yield is still historically low. We may be entering a goldilocks situation with low rates and strong earnings growth. Get long.