Does 1 Equation Hold the Key for Stock Prices?

NYSE: SPY | SPDR S&P 500 News, Ratings, and Charts

SPY – At first I thought it was outrageous to believe this 1 equation is only that mattered for stock prices. Then I saw it happen plain as day in February 2016. Now I believe it will happen again.

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It dawned on me this week that 1 simple equation holds the future for the stock market. And that same equation came into play in early 2016 when the fear of a recession and bear market was much higher than it is now.

Yet when this equation came into play, the 2016 correction ended and a lasting bounce began. The end result was a +23.6% gain for the S&P to close out the year.

Yes, that same equation is emerging on the scene now. And why I think the bull market will stay on track EVEN if the Fed doesn’t lower rates. EVEN if China trade deal doesn’t come together. And EVEN if economic data points to contraction.

I will spell it out for you below along with my recommended trading strategy to squeeze the most from this unique market environment.

The Equation

Dividend Yield on the S&P 500 > 10 Year Treasury Rate = Buy Stocks

And yes, the recent cratering of Treasury rates has this equation back in play as the S&P now pays 1.82% dividend yield versus the 1.54% for the 10 year.

I know. It seems too simple. Why should this matter so much?

Now picture large money managers. The Warren Buffet types with billions of dollars to invest and a world of patience to see things through no matter of short term volatility.

So the main choices before them are cash, bonds and stocks.

Cash is trash in a low rate environment.

10 year bonds now pay 1.54%. Which is historically low and quite risky that rates go up from here and thus the only way to insure that meager 1.54% return is to hold on til maturity. That illiquidity is also very unattractive.

Turning to stocks you would get a 1.82% dividend yield. So already ahead of the Treasury rate. Plus over the next 10 years it is pretty safe to assume that you will get at least a 3-5% annual appreciation on the stock prices. And that outlook includes the great likelihood of 1 bear market over that period.

This is a slam dunk win for stocks!

And yes it was the prime reason that during the darkest hours of early 2016, when economic data was increasingly pointing to a recession, stocks burst higher pretty much the moment the S&P yield was above the 10 year Treasury (about 2/8/16 when the bond rate fell to 1.75% stocks rebounded from a low of 1810 to end the year at 2238).

Recommended Trading Strategy

So yes, I am saying that the bull market is still in place. But this is not a Gung Ho bull market by any stretch of the imagination.

This is a Risk Off and Safety First bull market. That’s because there is still too much headline risk out there with the Fed, inverted yield curves, and especially US China trade. Plus economic has been coming in softer and softer (especially ISM Manufacturing down to 51.2).

So it says the stocks likely to outperform are conservative large cap stocks in defensive industries paying dividend yields above the Treasury Rate. And yes, the higher the dividend yield the better.

This is also a call to limit exposure to companies greatly affected by China trade. As we have already seen that negotiation goes from sweet to sour on a nearly weekly basis. We are always 1 bad Tweet or headline away from a 3% drop in stock prices.

And during those sell offs, it’s not just those companies most directly affected by China trade that drop like lead balloons. The same can happen for any variety of smaller, riskier, higher beta stocks.

However, once a deal with China is in place, then it will be time to get back to Risk On mode. Meaning to take the profits on conservative positions and switch out to more small and mid cap growth stocks as it will finally be their time to shine.

Your next step should be to check out some of the best conservative stocks out there highlighted in some recent articles I put on including:

7 Safest Stocks for this Volatile Market

10 Growth & Income Stocks…Emphasis on INCOME

Comcast POWR Ratings Breakdown: Wired for Upside

10 Perfect Stocks?

Wishing you a world of investment success!

Steve Reitmeister

…but my friends call me Reity (pronounced “Righty”)
CEO, Stock News Network

Editor of the Reitmeister Total Return

SPY shares rose $0.10 (+0.03%) in after-hours trading Friday. Year-to-date, SPY has gained 16.65%, versus a 16.65% rise in the benchmark S&P 500 index during the same period.

About the Author: Steve Reitmeister

Steve is better known to the StockNews audience as “Reity”. Not only is he the CEO of the firm, but he also shares his 40 years of investment experience in the Reitmeister Total Return portfolio. Learn more about Reity’s background, along with links to his most recent articles and stock picks. More...

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