Billionaire investor Warren Buffett says that the key to investing in the stock market is being greedy when others are fearful. But it’s also being fearful when others are greedy.
While share prices continue to make new highs, the bond market’s more cautious. Is the fixed income sector trying to send a warning to stock market investors?
The bond market
Ten-year government bonds currently yield 4.51% in the US and 4.86% in the UK. But the interesting thing is where they’ve been going recently.
Since the start of March, yields in both cases have been going higher. And there’s one major reason for this – inflation.
Source: Trading Economics
Returns on bonds are fixed. That means inflation – which makes the value of those returns fall in real terms – is a big risk.
When investors are worried about this, bond prices fall and yields rise. And that’s been happening recently.
By itself, that’s not a big surprise. But while the bond market is wary of inflation, the stock market isn’t. That makes stocks unusually risky, in relative terms. So what should investors do?
What should investors do?
In one way, stocks are always riskier than bonds. There’s more chance of a firm’s earnings going down than it not paying its debts.
As a result, investors who buy stocks should look for something to offset this. That means higher implied returns, which come from lower prices.
The equity risk premium measures how much of a discount stock investors get. In other words, how much they get paid for the extra risk.
Rising share prices and falling bond prices compress this value from both sides. And analysts have noted that it’s unusually narrow right now.
That makes equities – as a group – unusually risky relative to bonds. But I don’t think the solution is to stop buying stocks and look elsewhere.
Even when share prices are high, there are often names trading at unusually low valuations. And that’s where I think investors should look.
Where are the bargains?
One stock I’ve been looking at recently is MercadoLibre (NASDAQ:MELI). It’s sometimes referred to as Latin America’s Amazon, or something like that.
That’s a slightly lazy comparison, but it’s not entirely without merit. The firm operates the largest e-commerce platform in Argentina, Brazil, and Mexico.
The stock is 34% off its 52-week highs. And the main reason is that margins have been contracting as it looks to make life harder for competitors.
Focusing on growing the business while driving down costs for customers, however, is exactly what Amazon has done before. That’s why it’s so hard to compete with.
Source: Fiscal.ai
The falling share price means the stock now trades at its lowest price-to-book (P/B) ratio in years. And this is while reporting 40% annual revenue growth.
I think this looks like a really interesting opportunity. That’s why the stock’s on my list of shares to buy in June.
Inflation risks
The stock market’s ignoring the bond market’s inflation concerns. In some ways, that makes MercadoLibre an unusual idea.
In recent years, Argentina hasn’t exactly been famous for currency stability. That’s a genuine risk for investors to pay attention to.
The point though, is that this risk hasn’t been more attractively priced in years. And this is what investing in the stock market’s all about.
Stephen Wright owns shares in Amazon.
