The legs on the stock-market bull are starting to look a bit wobbly. That doesn’t inspire a load of confidence in equity investors who are hoping that the Year of the Ox could see the major stock-market indices push increasingly higher.
Many of us know that stock market valuations are looking stretched. But hopes that an earnings recovery from COVID-19, together with lots of liquidity from central banks and continued low interest rates would be enough to, if not propel, then at least underpin the stock market.
But the bond market has thrown a spanner in the works. The closely-followed 10-year Treasury has climbed to 1.3% for the first time in a year. Who knows where it could rise to next? Perhaps 1.5%, which would throw not just a spanner but a bunch of wrenches in the works.
The 10-year Treasury is closely-followed because it is a proxy for risk-free investing. If an investor can earn 1.3% without taking on any risk, then why would he or she want to put more money into equities at current valuations.
It is a question that many reluctant stock-market investors could be asking. The only reason they have been forced to consider shares is because bond yields and interest on savings accounts have been so abysmally low. But now the bond market has provided them with a way out.
Trouble is, higher bond yields could be the market’s way of signalling that it believes inflation could be a problem. But if rising consumer prices is indeed going to be a problem, then a risk-free return of 1.3% will hardly provide enough protection for our capital.
So, before we get sucked into ditching shares for bonds, think about why we invest in the first place. It is to put our money into assets that could not only keep pace with inflation but to soundly beat rising prices.
One of the best ways is to invest in companies that have pricing power. We probably have a good idea as to which ones they are. They are the ones that we moan about when they raise prices. But guess what, we still have to buy their stuff because we don’t have a choice.
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Disclosure: David Kuo does not own shares in any of the companies mentioned.