Sunday, December 8, 2013

What's the Bear Case for a Market Downturn?

Barry Ritholtz, financial advisor and market maven, asked on his blog what's the bear case for stocks right now.

In my blog, I previously wrote why I did not think we were in a bubble, but anything can happen in the market, and only fools are complete sure of the stock market's future direction.

I wrote a response to Barry and I will expand on it here.

One of things that has supercharged the stock market is the lack of alternatives.  Gold has dropped precipitously, oil has done little for the last few years, and the Fed has ensured that interest rates have remained low.  Investors have been pushed into equities, and a lot of money has flowed into "safe" dividend plays like Proctor and Gamble ($PG) and Clorox ($CLX).  They are both at new yearly highs and coincidentally pay a 2.8% dividend, which is also around what the 10 year Treasury Bond is paying.

For conservative investors, the question becomes, why buy a risky asset like a stock (that can go down) when the 10 year pays about the same return?  If the "interest alternative" pays the same rate, why go to the alternative when you can make the safer play?

That's the bear case for me.  Although, I don't think it will cause a major shift back to fixed income at this point for a couple reasons.

1. There are tax advantages for dividends over interest.
2. Yes, stocks can decline, but the price of bonds can also drop if interest rates continue to rise.  Buying bonds now may result in larger capital losses than what investors might see in stocks.

Therefore, although I think this scenario will play out over time, I don't think it will happen at these levels.  I think 10 year yields need to reach 4% before we see a meaningful correction, and I can't see that happening any time soon, because the increase in borrowing cost will have major implications for government.

Just my take on things.  I'm not an economist, just an upbeat investor.   I don't have a position in the stocks mentioned in this article.

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