Cash is King!?
When a $6 plastic crown can fetch nearly $600,000 at auction, it’s safe to say the value has been inflated.
The tougher question for investors nearly a year into the Fed’s fight against inflation is whether buying falling stocks is smart or whether it makes more sense to take a 5% yield on safe-haven Treasuries, an equivalent equivalent to cash.
By one popular metric, investing in the stock market now pays about the same as short-term debt backed by the full faith of the US government.
Specifically, the earnings performance of companies in the S&P 500 SPX Index,
converged last week with the 6-month Treasury TMUBMUSD06M,
rate, with both reaching around 5%, for the first time in about 20 years (see graph).
US stock market earnings yield and 6-month Treasury rate converge in early 2023 around 5%
refinitive
Earnings performance looks at the past 12 months of earnings, divided by the stock price. It is also an indicator of which assets are overvalued or undervalued.
“I think the thinking is that bonds are back,” said Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research, noting that the two yields used to track more closely for many years in the 1980s and 1990s. “It’s probably new to a lot of investment managers and individual investors.”
Schwab’s house view on stocks has been cautious for some time, including that higher-growth stocks could be vulnerable to further pullbacks as the Fed continues to tighten financial conditions.
Jones said the prospect of earning 5% on bonds seems “very attractive, and probably allows an investor to ride more ups and downs in the stock portion of their portfolio, and not take on as much risk.”
Fund flows into bonds
Investors seem to like the higher bond yields today, with roughly $17 billion flowing out of US stock funds this year through February 15 and $4.2 billion flowing into Treasury funds, the strongest inflows into US government debt funds to start a year since 2004, according to BofA Global data.
“Why not take 4.8% or 5% on a risk-free return basis?” said Stephen Guilfoyle, founder and chairman of Sarge986, a private family trading operation, and a former NYSE floor trader. “I’m moving some of my cash to 3-month paper and I’m really a stock guy.”
The 3-month Treasury rate TMUBMUSD03M,
was near 4.8% on Friday, while the 2-year Treasury TMUBMUSD02Y,
was at 4.6% and the 10-year yield TMUBMUSD10Y,
it was around 3.8%, its second highest level of the year, according to Dow Jones Market Data.
US stocks ended the week mostly lower after the consumer price index showed inflation may need higher interest rates to recede more quickly. Economists at Goldman Sachs and Bank of America revised their forecasts to include interest rate hikes of 25 basis points in March, May and June, which would bring the Fed’s terminal rate to a range of 5.25% to 5. ,5%.
In January, investors trading in the federal funds futures market expected the Fed to stop raising rates to 5%.
Major stock indices still rallied in 2023, buoyed by hopes that a deep recession can be avoided and that the Fed could also cut the size of its interest rate hikes.
Josh Duitz, deputy head of global equities at abrdn, said stock prices currently reflect a “Goldilocks scenario” in which the Fed controls inflation but the economy experiences a shallow recession.
But he also believes that stock valuations “got out of hand” in the last 10 to 15 years of low interest rates, especially for growth stocks. Duitz believes that investors should prepare for higher rates for longer. “When the cost of capital is higher, those growth names are not as attractive,” he said. “Look at the cash that companies are producing and paying out to individual shareholders.”
Although below previous highs in 2023, the S&P 500 was up 6.2% on the year to Friday, the Dow Jones Industrial Average DJIA,
gained 2.1% more and the Nasdaq COMP Composite Index,
it advanced 12.6%, according to FactSet.
Where do the markets go from here? Who knows. Not everyone saw the value of the Notorious BIG wearing a cheap crown in a 1997 photo shoot, even though, as Rolling Stone magazine notes, it ended up being “one of the most famous hip-hop portraits ever taken.”
Read: ‘The risk is that we’re going to hit the brakes very, very hard,’ says Larry Summers
On deck for next week, the US stock market will be closed on Monday for Washington’s birthday. Existing home sales data for January are due Tuesday, while the Fed’s minutes from the February 1 rate-setting meeting are due Wednesday. But the big data point will probably be Thursday’s PCE index for January with a new inflation reading.
—Joseph Adinolfi contributed reporting to this article