Should Gentlemen Prefer Bonds?

There is this fixed income theme playing in my contrarian head since some time and I did some priliminary reading over the past few days to figure it out. The hike in diesel will surely stoke inflation, but much depends on how the INR will behave as the US Fed goes about mopping mortage securities from the US market. The USD has already started depcreciating post the QE3 announcement. The JPY will also join the party now that the central bank of Japan has also announced their own mop up act. Yes, the fact is that global events will always have a much higher impact on the landed cost of fuel (huge component of inflation) than the price cuts announced. It is perhaps because of this ‘imported inflation’ that the RBI chose not to dunk their policy rates (repo) despite the industry clamouring for it like a starving mongrel. Ergo yields remain high and the hypothesis that once the policy rates get lowered (step wise), fixed income trading positions will profit is still yet to be proven.

Peter Lynch’s quote comes to mind:

When yields on long term Government bonds exceed the dividend yield on the S&P 500 by 6% or more, sell your stocks and buy bonds.

Now, I don’t know how much of this still applies in the US markets as of today, let alone India but the chart below shows the historical trend of the dividend yield of the NIFTY over the past 13 years or so.

 

The 10 yr GoI bond yield has been moving in a range bound manner since the start of last calendar yield (see chart below from Bloombeg). It is around 8.18% these days. So, Lynch’s above equation evaluates to 8.18% – 1.48% = 6.7% > 6%.

But then yet another quote from Peter Lynch comes to mind and makes me all confused as ever:

Gentlemen who prefer bonds don’t know what they are missing

Sigh!

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