Tabell’s Market Letter – June 02, 1989

T IBUER.R.'5 Iil1iIRIET R.IETTIER 600 ALEXANDER ROAD, CN 5209, PRINCETON, NEW JERSEY 08543-5209 MEMBER NEW YORK STOCK EXCHANGE, INC MEMBER NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC (609) 987-2300 June 2, 1989 . In a.-recent .. survey–,, markej. ,,-tejJhnici!It8…..wr,eslt4– wlmt…90.!lOm.!Bta tist!cs-.!to be most cruc..,i,aI , in determining the market's course over the short term. Two-thirds of them- mentioned interest rates, and there is no reason to argue with this consensus. The market quite clearly, in the past year or so at least, has been highly sensitive to interest rate developments, moving up on the prospect of lower rates and weakening on the possibility of higher ones. We intend, therefore, to make interest rates the subject of this, and in all probability a number of subsequent letters. In these discussions we will be attempting to view the long-term historical perspective rather than the short-term relationship to which the technicians in the survey were referring. Indeed, those same technicians, familiar as they would certainly be with market history, would undoubtedly raise some of the questions regarding the long-term relationship of interest rates and stock prices that we intend to discuss. The watershed date for that relationship (at least the only such that will fall within the lifetime of readers of this letter) occurred in the Spring of 1957. At that point the yield for AA Corporates moved, for the first time in over thirty years, above the 4 level, rising in the process, above the yield on the Standard & Poor's 500. The relationship was reversed for a few short months around the bottom of the 1957 bear market, but, commencing with the 1958 stock-market upswing, the yield for the 500 fell below that of bonds and has remained there in the thirty-one years since. Interestingly enough the prior norm, stocks yielding more than bonds, had prevailed for thirty-plus years prior to the 1957 transition—back into the early 1920's. It is hard for investors today to envision a world where stock yields in excess of bond returns were the normal thing, but it was equally difficult for the previous generation, whose formative years were the 1930's and 1940's, to acclimate themselves to the current environment. Even the great Benjamin Graham had trouble with the concept. A plausible explanation for the shift in the relationship is a change in the conventional view of dividends. Those who remembered the 1930's, when dividends were cut and lor eliminated with great regularity, tended to view such an Income stream as a risKy-one…..wlfiChsnoultt..therefore comrn8.YIl-ii—-L I premium return. As we entered the 1960's, the magic word growth began to be regularly heard, and the view of dividends shifted to one which envisioned them as a steadily increasing income flow. Given this perspective, it was possible to justify a lower initial income from equities. The transition of the mid-1950's antedated by some ten years the emergence of another factor relevant to interest rates—increasing inflation. The period 1955-65 generally saw inflation at around the 1 level or a bit higher, and the yield on twenty-year Governments during this period remained in the 3-4 range. That decade was the foundation for the not-totally-unreasonable theory of a real interest rate, measured by subtracting the inflation rate from bond yields. This rate remained for the decade mostly in the 2-3 range. It was slow to respond to the accelerating inflation of the 1970's. By the middle of that decade, the real interest rate had actually turned negative, despite bond yields which, in 1974, surpassed 8.5. The first emergence of double-digit Treasury coupons, in 1980, still failed to produce positive real returns, since the inflation rate. at that point, was in excess of 12. The 1980's, however, were to be the decade of falling inflation. By 1983-85, the rate of price increases had dropped under 4. Bond yields, however, did not decline that much, and the yields in excess of 13 available in the summer of 1984 produced the highest real return—9—that has been seen in recent history. The period from 1984 to date has seen a sharp decline in bond yields, to 1986 lows under 8, along with a slight rise in the rate of inflation. This has lowered the real return on 20-year Governments to 4. The popularity of the real-interest-rate concept explains why inflation is probably, after interest rates, the second most important factor affecting the short-term direction of the stock market. If one believes in real interest rates, reduced inflation obviously leaves room for bond yields to come down and thus, presumably, for stocks to rise. One wonders, however, whether the true real interest rate is the 2-3 of the 1955-1965 era, the 5-9 of the early 1980's,-the 4 to which it has recently declined, or something else. It it likewise difficult to find in the history recounted above any convincing evidence of a long-term relationship between stock and bond yields. We have done very little here, we freely admit, other than raise questions, and we will probably, in future issues, be raising some more. We hope also, in the course of the discussion, to provide some tentative answers. ANTHONY W. TABELL DELAFIELD, HARVEY, TABELL INC. Dow Jones Industrials (12 00) S & P 500 (1200) Cumulative Index (6/01189) AWTmjs 2514.15 324.83 4586.74 No statement Or expression of opinion or any other matter herein contained IS, or IS to be deemed to be, directly or Indirectly, an offeror the soliCitation Of an offerto buy or sell any security relerred to or mentioned The matter IS presented merely for the convenience of the subscnber While we believe the sources of our tnformailon to be reliable, we In no way represent or guarantee the accuracy thereof nor 01 the statements made herein Any action to be taken by the subscriber should be based on hiS own mvestlgal10n and Information Delafield, Harvey, Tabelltnc ,as a corporation and Its officers or employees, may now have, or may later take, positions or trades In respect to any seCUrities mentioned In thiS or any future Issue, and such poSition may be dlf1erent from any views now or hereafter expressed In thiS or any other Issue Delafield, Harvey, Tabelllnc, which IS registered With the SEC as an Investment adVisor, may give adVice to ItS Investment adVISOry and other customers mdependently of any statements made In thiS or In any other Issue Funher information on any security mentioned herein IS available on request