This morning, both the Consumer Confidence Index and the Expectations Index delivered numbers below the consensus forecast and are down from the previous month’s readings. While not a huge surprise, this news just adds to the fatigue the market has been experiencing over the past few weeks. But, according to some investor sentiment indicators, the level of bullishness may have been getting a bit elevated. It can be a healthy sign that the markets have been able to work off some of the optimism. And, we still are hanging onto some of the best quarterly gains we have seen in years. It is not unusual for there to be a pullback when the stock market has had such lofty gains in a very short time period. Actually, it should be expected.

Understandably, many investors are still somewhat reluctant to jump back into the market. This is evidenced by the large amounts of cash on the sidelines. Many individuals are seeking safety in the form of money market accounts, CDs, and various high grade bonds which are all generating miniscule yields. They are trading one risk (market fluctuation) with other risks (lost opportunity, reinvestment risk). If seeking long-term capital appreciation, this is not the best strategy.

There has been a surge in demand for these investment grade corporate bonds, especially from the strongest issuers, in the midst of an environment where solid credits are becoming more expensive to buy. As the June 29th Barron’s points out, debt buyers have flocked to Merck’s 10-year bond at a yield-to-maturity of just over 5%, while completely ignoring Merck’s battered common stock which touts a 6% dividend yield. It is unusual to see a company’s dividend yield higher than its long-term bond yield. Furthermore, investors holding these bonds to maturity will realize a return exactly equaling the yield-to-maturity, again slightly over 5%. On the other hand, owning the stock allows for price appreciation in addition to the 6% dividend yield. What this suggests is that if the credit markets are correct, then conditions should remain supportive of stocks in general, limiting the severity of any correction in the stock market and attracting some of that lower-returning liquidity toward equities. We believe this puts a floor on how low the stock market will fall. Usually, abnormally high yields signal high risk, but because many stocks are still trading below normal levels, there are many worthy stocks with decent yields. As noted above, this dip in the level of optimism can be a plus.

THOR Team