By Bill Peattie I continue to favor stocks over bonds in the current market. The U.S. economy grew at a 4.2% rate in the second quarter, confirming my belief that the first quarter was severely impacted by weather. A variety of indicators signal continued slow but steady expansion overall, with no sign of a recession in sight. As far as I’m concerned, that is a favorable environment for equities. The other elements I consider are valuation, which, overall is acceptable given the level of rates, and sentiment, which corrected from somewhat overly optimistic levels in early August when the markets dipped. In addition, the headlines are helping, with the Middle East, Ukraine and a soft European economy generating the “wall of worry” that is usually helpful to equities. I’ve said several times that I wouldn’t be surprised to see a 5-10% correction somewhere along the way, which would be normal and healthy. However, every time the market drops 2-3% buyers come in and the market subsequently rallies to a new high. Buying into a rising market is difficult, and good stock picking will be increasingly important at today’s higher levels.
A quick review of compounding
What happens to $1 million over 10 years in different return scenarios? At 4% annually it grows to $1,480,244 and at 8% it grows to $2,158,925. Over 20 years those numbers are $2,191,123 and $4,660,957 respectively. All well and good, but using today’s 2.4% 10-year Treasury note, that $1mm becomes $1,267,650 and $1,606,938 respectively. In addition, bonds lose value as rates rise, so a bond holder risks taking a loss if he/she needs to sell before maturity. Either way, bond buyers face a dilemma, and I think a well-researched and carefully constructed equity portfolio has a far better chance of success for the next 10 years from today’s levels, despite the inevitable bumps that will happen.