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Crossing the thresholds

21 February 2012 By Robert Cole

Some nice round numbers have equity investors smiling. The Dow Jones industrial average crossed the 13,000 level for the first time since before the crisis and Britain’s FTSE 100 index is headed towards 6,000. Many in the market may be wondering if the run can be sustained. But the real danger may be lurking for bondholders.

The FTSE 100 index crossed 6,000 for the first time back in April 1998. It has risen through the mark and slipped back below it 41 times – not counting the occasions it flip-flopped during intra-day trading. In that context, investors might wonder if the event is even worth marking, let alone celebrating.

The warming U.S. economy, coupled with encouraging news on the European front, accounts for much of the renewed confidence. Investors are also attracted by what looks like discounted value. In the United States, the multiple on the more broadly based S&P 500 index, at 12.5 times forward earnings, is below the 25-year average of 15. The UK equivalent is 10.2 times. The first time the FTSE 100 hit 6,000 the forward price-to-earnings multiple was 18.9.

If recession hits and corporate earnings decline, hindsight will reveal the major indices to have been deceptively cheap. Any remaining potential upside, meanwhile, may do little more than compensate for the inherent risks in stocks. Debt markets, however, look more precarious.

Yields on 10-year bonds issued by the U.S. and British governments are still settled around 2 percent. That suggests debt instruments are as dear as they have been at any time in modern market history. They also offer little, if any, protection against inflation.

True, monetary policy on both sides of the Atlantic is about as lax as could be. What’s more, the Japanese precedent shows that bond yields and equities prices can stay persistently low together. But any feelings of vertigo by equity investors are probably misplaced. It is expensive sovereign bonds that are more likely headed for an overdue fall.


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