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CLICHES ARE A DIME A DOZEN. The latest example is "The New Normal," which, unlike the aforementioned example, is bereft of any intrinsic meaning. But by dint of constant repetition in the public discourse, it has entered the lexicon.
Largely forgotten have been aphorisms whose wisdom is self-evident. While I have been taken to task for having cited Will Rogers's observation on more than one occasion, it nonetheless remains apt: return of capital at some point becomes more important than return on capital.
Yet the great American humorist's perspicacity is evident, even painfully so, in today's financial markets. How else can you explain investors' acceptance of such paltry bond yields? Why would they eagerly scarf up bonds yielding less than any time history? And why would they opt for corporate bonds that yield less than the stocks of the very same companies?
Part of the explanation is behavioral, which is a euphemism for the inherent irrationality of most humans. A cat that jumps on a hot stove won't ever hop upon a stove, hot or cold, ever again. So it is with many individual investors.
They suffered through two market crashes in the past 10 years -- the dot,com collapse at the turn of the century and the latest, greatest crash since the peak in 2007. The straw that broke the camel's back (for all you cliché fans out there) was the "Flash Crash" in May, to which Securities and Exchange Commission Mary Schapiro referred Tuesday as a deterrent to individuals' participation in the stock market.
That doesn't explain the behavior of putatively rational institutional investors who are scooping up bonds from corporations that yield less than what their common stocks' dividends yield.
For instance, Johnson & Johnson (JNJ) issued 10-year notes at a yield under 3% last month while its shares yield 3.7% at Tuesday's closing price. Let's leave taxes out of the equation; even if the Bush tax rates revert at the turn of the year to taxing dividends at ordinary-income rates, it shouldn't matter to tax-exempt entities such as pension funds.
But for other, tax-paying investors, it can't be trivial. The current tax rate of 15% on dividends is relatively investor-friendly, even though that stream of income already has been taxed at the corporate level. To raise the levy on dividends to same rate as on ordinary income in 2011—which is slated to jump to 39.6%--cannot help but have a negative effect. Without Congressional action, that's what will happen Jan. 1.
Those considerations aside, from the 1930s through the 1950s, stocks consistently yielded more than bonds for the simple reason that equity was riskier than debt. Such reasoning seems almost antediluvian, yet it was accepted at the time—even though it was Federal Reserve policy through much of the period to peg Treasury bond yields at below-market levels.
More recently, super-solid stocks with attractive yields have shown the ability to recoil and to hit investors. Take Intel (INTC), which has roughly lost a quarter of its value since May. That the chip-maker's stock yields 3.4% vs the 2.60% on the 10-year Treasury provides cold comfort to investors who rode Intel's shares down to 18 from 24 in a mere matter of months.
Similarly, the acquiescence to current low bond yields is perfectly rational if the Federal Reserve continues to peg its federal-funds target virtually at zero, not only in 2010 and 2011 but perhaps all the way to 2012. That stance would be consistent with a two-year Treasury note yielding just 0.5%.
So, perhaps the so-called New Normal isn't so different from the old one. Baby Boomers who have to tap principal in a few years need to become acquainted with bonds, perhaps for the first time. That means "cheap" stocks could remain so. Or at least until Will Rogers's aphorism no longer applies.
Comments? E-mail us at online.editors@barrons.com
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