My long-term skepticism regarding stock returns in the next decade has two basic roots: the unacceptably low yields associated with the market as a whole (a problem we can dodge through intelligent selection of individual stocks), as well as a cultural problem--the growing aversion of savers and investors toward equities. Often the latter is a headwind that can persist for the better part of a generation, but in this hyperactive age, a few data points this week from the bond market make me wonder if perhaps this process is already well on its way toward a point of terminal absurdity.
Consider this: On Thursday, Builder holding
Johnson & Johnson JNJ sold $550 million of 10-year notes at a yield of 2.95%. On the same day, J&J's common stock closed with a dividend yield of 3.69%. Yes, you're doing the math correctly: We could set aside any potential for the dividend to grow, or the stock price to rise for an entire decade--in nominal terms at that!--and still pick up 74 basis points (1/100th of a percentage point) of annual cash return by owning Johnson & Johnson common stock instead of this bond.
Yes, I know stock prices can be volatile, and the buyers of these bonds know exactly what they're going to get and when (well, virtually--J&J is a legitimate triple-A credit). But 10 years is a long time to smooth out the bumps. In light of the fact that the bond cannot provide any growth of principal by the time it matures, these stats are properly eye-popping:
- If J&J grows its earnings per share by 8%--which not exactly a heroic forecast, considering that more than half of that figure could come from share repurchases alone--the company would earn $10.15 a share in 2020. The stock would have to trade for less than six times earnings for investors to see no capital gain--in other words, for it to underperform this bond issue in terms of price alone. And by the end of 10 years, a flat stock price plus a constant payout ratio would spell a dividend yield of 7.97%!
- Even if we assume J&J's bottom line doesn't grow at all, leaving only share repurchases (I estimate 4.3% worth from retained earnings in a steady-state) as a source of per-share growth, a flat stock price ten years hence would still mean ending up with a P/E of 8.2 and a yield of 5.62%. (Sure, the stock market has bottomed out at high single-digit P/Es in the past, but J&J is hardly a run-of-the-mill member of the market.)
As for income, that 74-basis point spread will grow as Johnson & Johnson raises its dividend. At the 4.3% per-share growth/flat-bottom-line scenario, common shareholders end up with a 267 basis point premium after 10 years; at 8% growth, that widens to 502 basis points. In fact, the accumulation of these dividends--even without the helpful benefit of dividend reinvestment as valuations fall--is large enough that J&J's common stock could actually
lose more than 17% of its current market value over 10 long years under the scenarios above and it would still generate results superior to that of these bonds!
Don't get me wrong: Johnson & Johnson is not a perfect company. It might otherwise have been close, but I am uncomfortable with the product recalls announced in the past year (and a little relieved that no more cockroaches have been spotted of late). But J&J is huge, diverse, massively profitable and deeply entrenched in a part of the global economy that is almost certain to grow in the decade to come. Better yet, the stock is now cheaper relative to per-share earnings and dividends than it's been in decades. With these figures in mind, let alone any fear of inflation making a comeback before the year 2020, why would anyone buy the bond over the stock?
Because it is a bond, of course! Don't we all know by now that the stock market is always a terrible place to invest? Don't we all know that bonds guarantee us our money back? (As long as the issuer stays solvent--no real problem in this case--and the buyer doesn't particularly care how much that money will buy ten long years from now …) I'm being sarcastic, of course, but I'm not sure how else to react. If investors are so determined to own bonds for the sake of their being bonds, this is the kind of comparisons we get.
Johnson and Johnson hasn't been alone in raising some very cheap dough from the increasingly desperate buyers of bonds. Among others, Harvest holdings
Magellan Midstream Partners MMP and
NuStar Energy NS both dipped their hands into that gushing well this month, and the comparison in yields may be just as remarkable. Magellan raised $300 million at a yield of 4.29% on Aug. 4; on that day, the units were priced to yield 5.92%. Not only is the yield premium for the equity of 163 basis points more than double that of J&J, but with its regulated revenues tied directly to the Producer Price Index, Magellan's equity is a very attractive hedge against any rise in inflation. (No one is likely to describe these low-yielding bonds that way.) The interest rate of the bond, naturally, is fixed for the full 10-year term. For its part, NuStar's $450 million issue at 4.82% gave its units a still-larger yield premium of 244 basis points.
This all adds up to an incredibly obvious disconnect in the markets that has appears to have little or nothing to do with potential risks and returns. An academic might say this is a bet on outright deflation, but I'm not prepared to give the market that much credit for sense of purpose. This is no more than the pursuit of past performance, in my view, and may end no more joyfully than the performance-chasing of the past 20 years.
The stocks and partnership units I've mentioned may not be at world-beating bargain levels, though J&J is trading comfortably below my Dividend Buy price of $68. It may well be that stock vs. bond comparisons like these are actually telling us that these corporate bond issues are overpriced--yielding too little and bound to disappoint today's eager buyers. Either way, despite with my ho-hum secular attitude toward stocks, I'm happy to own some good, healthy yielding ones over bonds like these any day. If this goes on much longer, I may even have to haul out the S-word: silly.
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