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Tuesday, August 9, 2016

Comparing Apples to Oranges

A well known dismissal of an argument is the claim that one is comparing "apples to oranges". I came across this a couple of weeks ago in an article that claimed comparing dividend paying stocks to bonds is an "apples to oranges" comparison. Unfortunately I didn't write down the article so can't quote it directly.
As a past long time Economics instructor I am always amused when I see this "apples to oranges" phrase invoked. As it happens most Economics instructors compare apples to oranges in their microeconomics class when teaching the concept of substitute goods.

Simply, one can imagine the housewife or househusband pushing the grocery cart and noticing that the price of apples has risen and the price of oranges has fallen. What will they do? How will this affect demand and hence price?

The implication for dividend stocks and bonds is straightforward. At the margin, investors view the 10 year Treasury and dividend stocks as substitute goods in the world of needing to generate an income stream. Drive up the yield on dividend stocks and drive down the yield on the 10 year Treasury note and what do you think investors will throw into their shopping cart? What do you think will happen to prices.

It interests me considerably that so many market gurus have totally missed this market. As cited in Barron's this past weekend, Gundlach, head of DoubleLine Capital and the new "bond king" said "sell everything", Druckenmiller, Soros, and even Carl Icahn have been seriously negative on stocks. After the brexit vote the market was supposed to fall off a cliff. And yet it didn't, instead it set new record highs.

Now I'm not claiming I know where the market is headed but the fact is that to this point these great investors have missed a sharp upturn and one has to question what they are missing.

Maybe the apples to oranges comparison above has something to do with it, especially when on a daily basis we have thousands of baby boomers turning 65 and struggling to produce an income stream, as noted above.

Other thoughts have also crossed my mind as I listen to some prominent strategists. leading the biggest investment banks in the country present the bearish argument on CNBC. Their wailing and gnashing of teeth over China slowing, anemic corporate profits, and even the economy failing to respond to an aggressive Federal Reserve are well known.

But what if we step back a few years and I presented you with the proverbial crystal ball which showed a scenario with oil prices below $50.barrel, a 0.5% federal funds rate, a 10 year Treasury note yield of  1.5%, an unemployment rate below 5%, and inflation below the Fed's target? What if the crystal ball also showed that the U.S. economy was the best in the world and that the investment climate in most of the rest of the world was scary.

Some people foreseeing this in the crystal ball would have said sell everything that isn't tied down and put it into the market. Yet this has been the scenario we have seen unfold and again the best minds in the market have totally missed it to this point.

To me Bogle's observation that he has never known anyone or known anyone who has known anyone who can predict the market is apt here.

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