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Should You Buy Stocks, Bonds, or Gold?
We witnessed a rather extraordinary confluence of events: The Dow stormed to a 13-month high while gold reached another record high (in nominal terms). Meanwhile, the ratio of bids to amount offered in $40 billion three-year Treasury note auction was the highest since 1990, pushing the yield on the issue down to 1.40%. Why is this unusual, and what does it mean for investors?
A rare correlation
Last few days events highlight a period in which stocks, gold, and government bonds have been positively correlated -- i.e., all three have been rising simultaneously -- which is highly unusual. The probable culprit behind this state of affairs is the Fed, which has flooded the system with money through bond purchases and lowered short-term interest rates to zero. As a result, investors are frantically seeking yield or the promise of capital appreciation wherever they can find it. They would rather take unconsidered risk than earn nothing while they sit on their hands.
When will it break down?
What would it take for this Neverland market, in which all assets go up, to break down? The fear of a rate rise could do the trick. Last week, the Fed explicitly identified inflation expectations as one of three factors it is monitoring in deciding when to raise rates. The market-implied expected inflation rate, based on Treasury bond and inflation-protected Treasury security prices, reached 2.22% annually over the next 10 years -- the highest figure in over 14 months.
What to hold when the cards are laid down
Once the correlation breaks down, what should investors be holding in their portfolios: The SPDR S&P 500 ETF (NYSE: SPY), SPDR Gold Shares (NYSE: GLD), or T-bonds? As a value-driven investor, I can't recommend buying the S&P 500 or T-bonds in this environment; both look overvalued. As for gold, some exposure is useful as an inflation hedge. Beyond this, investors who can drill down and focus on individual stock names will reap the rewards. High-dividend payers such as Pitney Bowes (NYSE: PBI), Eli Lilly (NYSE: LLY), Bristol-Myers Squibb (NYSE: BMY), or Kraft (NYSE: KFT) might fit the bill,