TINA no longer supports stocks … the short term yield curve is mighty attractive … the market and the Fed are finally aligning … stocks still face a valuation problem
Once upon a time, in a market far, far away, there was a narrative that helped stock prices remain buoyant through rain or shine…
“There is no alternative.”
This phrase, affectionately referred to as “TINA,” was a support beam for the stock market. And rightfully so…
Coming out of the Great Financial Crisis, the Fed pegged interest rates to near-zero, so there was no meaningful return from cash or short-term instruments…. bond yields offered little return… commodities enjoyed a brief moment in the sun from 2009 lows through spring 2011, but then suffered a multi-year crash… similarly, gold outperformed until 2011 when it fell into a multi-year bear market… Bitcoin was under the radar of 99% of investors…
That left the stock market.
But, oh, what a market it was!
Stocks swaggered through the early 2010’s with a confidence that came from the “Bernanke Put.” Anytime things looked wobbly, stimulus dollars flooded the economy/market, saving the day.
As a quick refresh, in the wake of the great financial crisis, then-Federal-Reserve-Chairman Ben Bernanke made it an unspoken mandate to prop up the stock market
He accomplished this through Quantitative Easing (QE).
As you’re likely aware, QE is a monetary policy strategy used by central banks around the world. The central banks buy various securities such as bonds, federal agency debt, and mortgage-backed securities to increase the supply of money sloshing around the economy. Hopefully, that leads to more businesses and consumer lending, which stimulates the economy.
Of course, much of the sloshing money inevitably finds its way into the stock market (either directly or indirectly), which helps drive up prices.
So, stock investors loved QE.
I’ll show you the chart illustrating this in a moment, but first, here are the numbers:
QE 1 from December ’08 through March ’10: the S&P gains 42%.
After QE 1 stops: the S&P falls 11%.
QE 2 from November ‘10 through June ‘11: the S&P gains 24%.
After QE 2 stops: the S&P falls 14%.
Operation Twist from September ‘11 through June ‘12: the S&P gains 24%.
After Operation Twist stops: the S&P falls 6%.
QE 3 from September ‘12 through April ‘13: the S&P gains 16%
Here’s the crude version of how that looked.
Chart showing the S&P rising and falling based on Ben Bernanke's QE and lack thereof
Source: StockCharts.com
Bottom line: With no major competition from other asset classes, and with the full support of the Fed, there truly was no alternative to stocks.
We’re no longer in that world.
For the first time in decades, we have a Fed that’s hostile to asset prices. And as Wall Street comes to grips with this, it’s leading to the best income options in years.
Right now, the two-year Treasury yield is pushing toward 5%, its highest level since 2007
Yesterday, the two-year Treasury yield hit 4.93%. It’s pulled back to 4.88% as I write Friday morning, as bulls try to shake off recent market wobbles.
What’s that, you say? You don’t want to lock your money up for two years? You want more liquidity?
Fine – how about a three-month bill with a 4.82% yield (annualized)?
If you’re willing to go to six months, the yield pops up to 5.04% annualized.
Why wouldn’t a conservative-minded investor… or pension fund… or retiree needing cash flows… or long-term endowment… hide out in short-term bills and bonds until the storm clouds pass by?
Especially in light of the fact that “cash” now yields more than the traditional 60/40 portfolio (60% stocks, 40% bonds).
Here’s Bloomberg with those details:
For the first time in more than two decades, some of the world’s most risk-free securities are delivering bigger payouts than a 60/40 portfolio of stocks and bonds.
The yield on six-month US Treasury bills rose as high as 5.14% Tuesday, the most since 2007.
That pushed it above the 5.07% yield on the classic mix of US equities and fixed-income securities for the first time since 2001, based on the weighted average earnings yield of the S&P 500 Index and the Bloomberg USAgg Index of bonds…
The steep jump in those payouts has reduced the incentive for investors to take risks, marking a break from the post-financial crisis era when persistently low interest rates drove investors into increasingly speculative investments to generate bigger returns.
The reality is investors finally have an alternative to stocks. And from the looks of it, this alternative is growing more attractive.
That’s because rates are likely headed higher as the Fed follows through on its promises
Here’s Forbes, boiling it down:
The reason interest rates are going higher than you thought is that the inflation rate keeps heading up once all the measures are in and revised.
The latest reported such figure, the core personal consumption expenditure index, aka “the PCE,” surprised analysts by coming in higher than expected.
The January, 2022 PCE, reported on February 24th, came in at 5.4% while most had anticipated 5.0%. This was an increase of the December, 2023 number of 5.0%.
In addition, revisions to the consumer price index trended upward rather than the same or downward, another indication of inflation’s firm grip.
The fixed income markets of bonds and bond-related securities don’t wait to see what the Fed will do about it — “gee, I wonder if the Fed will act? — no, the markets already figure it out and rates go up.
That’s because the Federal Reserve people know that to bring inflation down, they have to take actions that move rates further up.
On that note, traders are finally pricing in a “terminal rate” from the Fed of between 5.25% and 5.50% come December of this year.
We see this by looking at the CME Group’s FedWatch Tool that shows us the probabilities that traders are assigning to various rate levels in upcoming months.
As I write Friday morning, a plurality of traders (32.2%) sees the Fed Funds target rate at 5.25% – 5.50% in December.
Guess how many traders anticipated that target just one month ago?
1%.
The good news for stock investors is that Fed- and market-expectations are finally aligning
That’s going to help remove one headwind for stocks in the months to come.
But there are other stumbling blocks that investors need to consider thoughtfully.
For one, take valuations.
The S&P’s current price-to-earnings (PE) ratio clocks in at 21.5.
That’s high. It’s not “bubble” high, but the S&P’s long-term average PE ratio is 16. The median is even lower, slightly less than 15.
Does today’s stock market deserve this premium valuation?
Well, let’s consider the characteristics of our current economic and investment landscape.
Are interest rates near historic lows? No.
Is the dollar weak? No.
Tying back to the beginning of this Digest, are we in a world of QE? No, we’re in the opposite – the Fed is actively engaging in quantitative tightening (QT).
And as we’ve stressed today, are there now viable income alternatives to stocks? Even to the traditional 60/40 portfolio?
Yes. Attractive ones.
Okay, well, then what justifies the stock market having a PE ratio that’s 31% more richly valued than the average stock market valuation?
I don’t have a good answer.
It’s certainly not earnings, at least for the first half of the year.
From FactSet, which is the go-to earnings data analytics group used by the pros:
Looking ahead, analysts expect earnings declines for the first half of 2023, but earnings growth for the second half of 2023. For Q1 2023 and Q2 2023, analysts are projecting earnings declines of -5.7% and -3.7%, respectively.
So, again, why is the S&P’s PE ratio so high?
Here’s a thought exercise…
Remember what goes into a PE ratio. There’s 1) the stock price, 2) the amount of earnings, and 3) the PE multiple itself, which is a proxy for investor sentiment.
Now, in the next few months, let’s say that earnings do, in fact, decline as expected.
All else equal, that will drag down stock prices.
So, if we’re to avoid that… actually, no – if we’re to “overcome that and enjoy a rip-roaring bull market,” then that will require the PE multiple to rise, meaning investors will have to grow very bullish and be willing to pay a higher price for fewer dollars of earnings.
Is that going to happen? From today’s already-richly-valued PE of 21.5?
Well, anything can happen.
But it would have happened far easier back in the 2010’s when TINA ruled the day and the Fed had Wall Street’s back.
But now, there’s finally an alternative.
We want to hear from you
To what degree are you eyeing the bond and short-term cash market these days? Or have you already parked some capital there?
If so, what’s your preferred investment?
How are you viewing this fixed income allocation in light of your overall investment goals and portfolio makeup?
