The stock market is down ~ 6% since our last update and as such, bonds have rallied. At the risk of stating the obvious, basic supply and demand gives a very top level approach to why. For example, depending on the figures used, 2009 saw an inflow to bond mutual funds of between $357 billion to $375 billion. This was the highest recorded since 2004. To date, we have seen around $150 billion flowing into bond funds, putting us just shy of those record numbers (if 2010 continues on this pattern). However, the record flows are not what are surprising. What is surprising is the level of yield investors are willing to accept in light of investment alternatives.

To illustrate, let us look at Johnson & Johnson. Currently JNJ stock offers a dividend yield of ~ 3.6%, while its bond, maturing in 2017, offers a yield of ~ 2.8%. So why would an individual investor make this choice? Possible explanations include a perception that the company will soon cut its stock dividend or a poor estimation of the underlying business risk. Being literally one of a handful of companies that have maintained their AAA rating and have increased their dividend every year since 1972, we do not see either of these being major risks. What we do see is that this example is one of many situations that represent a dislocation within the financial markets. Investors have given absolute preference to bonds over stocks. As is the case with JNJ, investors are saying they are willing to take a lower yielding investment and give up the potential upside appreciation in preference for holding fixed income. We would argue that owning the stock is a better (and more rational) investment decision.

Events like this show us how easy it is for market participants to lose sight of the big picture and focus on the news of the day. Although it can make it tough for rational investors to maneuver in the short-term, it does provide for long-term opportunities to build wealth.

Sincerely,

Your THOR Team