Are Low Rates Really Driving This Market?

low rates

low ratesThe common argument we are hearing lately is that the equities markets are being driven higher because they are the most attractive place for investors to put their capital to work. People making this argument like to add that the equities markets themselves are not providing great opportunities, they are simply better options than the terribly low returns available to investors in the bond market.

This argument makes a lot of sense. With interest rates still ridiculously low and real estate still questionable, anyone with capital to invest doesn’t have too many options. However, the argument may be getting more credit than it actually deserves.

Mark Hulbert from MarketWatch published a piece this week that explained why a European Strategist names Vincent Deluard referred to this argument as “the most overrated argument in favor of equities.”

Deluard’s Logic

Hulbert goes out of his way to make sure we understand that Deluard isn’t just some chump. He actually knows what he’s talking about and has numbers to back it up.

Deluard has researched the difference between the earnings yield of the S&P 500 and the yield investors could get from 10-year Treasuries for every year dating back to 1945. What his research found was that there is almost no correlation between the two numbers.

The stock market has not historically performed better in periods when its yield was significantly higher than the 10-year Treasury yield. On top of that, when the spread between the two yield has been where it currently sits, the stock market has historically underperformed.

So What’s Driving This Market?

Hulbert provides a good bit more statistical evidence to back up Deluard’s argument. Here is their bottom line:

To be sure, the stock market isn’t necessarily doomed just because the bulls are relying on a flawed argument. But if you can’t come up with a better argument for why the stock market should go higher, then you should be looking for ways to cut back your equity holdings rather than increase them.

I don’t disagree with Hulbert’s analysis that markets are not going up because people can’t invest in bonds. He makes a lot of logical sense and has put together the thorough statistics to back up what he is saying. As far as the evidence, he’s done a great job with this article.

Hulbert’s False Assumption

In my opinion, there is one glaring false assumption in Hulbert’s piece. Why does anyone need an explanation for why the market is going higher? Why can’t we just acknowledge that the current trend is up, and that trend will end at some undetermined future time?

The biggest problem with most of the financial journalism today is the constant need for predictions. In my experience, no one is very good at predicting the markets, so why can’t we stop asking people to try? Imagine if we just focused on reporting what was actually happening today and let tomorrow worry about itself. Wouldn’t that be an interesting world?