Now that the first quarter of 2013 has come to a close, let’s take a look at capital flows. The first chart below shows stocks (S&P 500) against bonds (10 year Treasury). Typically, money moves back and forth between stocks and bonds as investors are either comfortable with taking risk or feel risk adverse. Since bond prices and interest rates move in opposite directions, we can expect the 10 year Treasury yield to move in the same direction as stocks during typical market movements. This has been the case over the past few months but the two are now starting to diverge with rates falling as stocks continue to make new highs.
S&P 500 (top) and 10-year Treasury rates (bottom) – 9 months
This would generally be a warning sign that stocks are getting ahead of themselves and will eventually start to fall to catch up with lower bond yields. However, it’s important not to look at this in a vacuum. Instead we need to follow capital flows in all asset classes throughout the world to get a true feel for what’s happening and hopefully find an answer for the divergence.
I think the real answer for this divergence is the deterioration and exit of capital from Europe. With so many now fearful of capital controls and confiscation of deposits/assets, the Euro is under strong pressure as people look to sell their Euros to move the money into US Dollars as a safe haven (as discussed earlier this week). This capital is being driven into both Treasury bonds AND stocks, driving both markets higher along with the US Dollar.
This can also be seen if we look at the stocks that have outperformed during the first quarter. Value stocks have led this climb higher over growth. Take a look at the S&P Value Index relative to the S&P 500 and S&P Growth Index:
S&P Value (green) vs S&P 500 (red) vs S&P Growth (purple) – Year-to-date
Lastly, along with the financials seeing nice gains from the housing recovery (which are considered value stocks), the leaders have been the big, blue chip, household-name, dividend payers like Johnson & Johnson, General Mills, Pepsi, etc. These companies have exploded to new highs while the stocks that I would consider to be the prime growth stocks have not.
When I think of a growth stock, a company like Under Armour comes to mind (and is a stock I have in growth portfolios). They’re growing at double-digit rates, still relatively small at only a $5.4 billion market cap (as compared to Nike at $47.6 billion), and do not pay a dividend because they’re reinvesting earnings into future expansion. Those are the key starting points that you look for in a growth company, and I would expect to see it leading the market but it’s nearly 20% off its high. In Under Armour’s case it is company specific reasons that the stock is off its highs, but it’s a similar story for many other growth stocks that I follow.
Blue-chip, Dividend Payers vs. Under Armour (light blue) – Year-to-date
It appears this new capital is seeking both safety in Treasuries as well as higher performance in stocks, but wants the safety of the blue chips with the 3%+ dividend yields. How growth stocks perform moving forward will tell us a lot. If they begin to catch up, it’s a good sign that this bull in stocks can continue. If they don’t and continue to slide, it’s a sign that economic growth may be slowing again and an indication that Treasury yields are right in leading things lower.
I hope everyone enjoys the weekend and gets to spend time with family and friends whether you celebrate Easter or not. Either way, there’s some good basketball to watch!
Nick