Don’t look now, but TINA has an alternative

Would you rather buy a risk-free long-term Treasury bond with a yield above 3.5% or try your luck in the stock market? The jury is apparently still out among investors, but at least they are debating the issue – as has rarely been the case in the post-financial crisis era.

Consider how the investment landscape has changed. In the 13 years to 2021, many investors have viewed stocks as the only viable option. Due to continued loose monetary policy, the S&P 500 index has returned 16% annually, crushing the 2.5% total return of a Treasury portfolio and the annual return of 6.3 % of high quality corporate debt. Investors would have been forgiven for forgetting the inherent risks of stocks, as outperformance has also been remarkably consistent over this period. This gave rise to the prevalence of the motto “there is no alternative” – or TINA – in US stock markets.

The market is now moving in ways that many traders have not experienced in their professional life. Federal Reserve Chairman Jerome Powell has pledged to keep interest rates high for an extended period to fight the worst inflation in 40 years, meaning corporate financing costs are expected to remain high and that bonds can suddenly sustain themselves as long-term strategies.

It’s a return to a time and interest rate environment in which equity excess returns were far less juicy and less consistent. Indeed, in the 25 years leading up to the financial crisis, total excess returns of stocks over Treasuries were about a third larger than they were in the 13 years after 2008. (1) If the market reverts to this paradigm, investors might need to think more seriously about whether 4.5 percentage points is appropriate compensation for the risk of plunging the less predictable equity market headlong into a possible recession. Maybe some will share the difference and the 60/40 stock portfolio – which has been declared irrelevant 1,001 times – will come back into vogue.

Admittedly, both asset classes have their risks, but at least they don’t seem to be strongly correlated. For equities, investors should fear that the Fed’s inflation fight will undermine resilient consumer trends and business investment and push the economy into recession. Economists polled by Bloomberg put the odds of a slowdown at around 50% over the next 12 months, but there is considerable debate over its magnitude and the extent to which it would nullify earnings. For their part, longer-term bonds run the risk that high inflation will force the Fed to raise interest rates even further. Of course, in the worst case scenario – stagflation – bonds and stocks will continue to take a beating.

Then there’s the optimistic “soft landing” narrative, in which the Fed declares victory over inflation without inflicting too much pain on workers and consumers. In truth, any of these outcomes seem conceivable, and that’s why the projections are all over the map. Looking to the end of the year, the median analyst polled by Bloomberg expects 10-year bond yields to rise from these levels to 3.17%, implying prices will rise, but the range is wide. 2.55% to 4.1%. The median equity strategist predicts that the S&P 500 will close at 4,300, but the range implies anything from a further 12% decline to a 32% rally by the end of the year.

Fund investors aren’t getting much clarity on the issue themselves. Money has been pouring into money market-style exchange-traded funds over the past week, including the SPDR Bloomberg 1-3 month T-bill ETF, but buying speculative stocks is hardly a thing. From the past: The ProShares UltraPro QQQ – which seeks to deliver three times the daily performance of the Nasdaq 100 Index – was also among the ETFs that saw the most inflows over the past week.

Ultimately, the market is still a long way from settling on a new favorite asset class, and that can be a good thing. The higher interest rate environment heralds a return to hard work in investing – constantly reassessing the balance between risk and reward instead of going full steam ahead into a single asset class. That too could eventually change, especially if the Fed sticks to the soft landing scenario and the economy returns to its 2009-2021 status quo. But for now, investors are simply going to have to face a world of tough choices.

More from Bloomberg Opinion:

• Fears of rising rates are hitting people where they live: John Authers

• Transfer your savings account to an online bank now: Alexis Leondis

• Wall Street squirms as Main Street gets relief: Conor Sen

(1) Neither sample includes the year 2008 itself, as this would significantly alter the numbers.

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Jonathan Levin has worked as a Bloomberg reporter in Latin America and the United States, covering finance, markets, and mergers and acquisitions. Most recently, he served as the company’s Miami office manager. He holds the CFA charter.

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