NEW YORK (Reuters) – Soaring interest rates are providing investors with attractive alternatives to equities, complicating the situation for equities in an already difficult year.
For years, investors could easily justify a preference for stocks because other assets offered paltry returns as the Federal Reserve kept rates at historic lows, giving rise to the acronym “TINA” or “it there is no alternative”.
The years when TINA dominated were good for the US stock market. The S&P 500 has gained around 600% from its March 2009 financial crisis low through the end of last year, easily beating a plethora of other investments.
That calculus has changed dramatically as the Fed raises interest rates to head off the worst inflation in decades, bolstering yields on everything from Treasuries to money markets. It’s more bad news for US stocks, as they struggle to regain their footing after a beating that has included a 22% decline in the S&P 500 so far this year.
“As interest rates continue to rise, there are more choices to capture total return or income without assuming equity market volatility,” said Michael Arone, chief investment strategist at State. Street Global Advisors. “This will continue to put downward pressure on stocks.”
Bond yields have soared this year, with the yield on two-year Treasuries jumping to more than 4.3% earlier this week from 0.73% at the end of 2021. Short-term Treasuries have often reported well below 1% over the past 15 years.
Yields on many Treasuries – which are considered virtually risk-free if held to maturity – now eclipse the S&P 500 dividend yield, which recently stood at around 1.8%, according to Refinitiv. data stream.
“The concept that there is no alternative to stocks is no longer true,” said Walter Todd, chief investment officer at Greenwood Capital.
There are many signs that yields are attracting investors. State Street’s SPDR Bloomberg 1-3 Month T-Bill ETF, which measures an index of one- to three-month Treasury bills, on Friday had seen net inflows of nearly $9 billion so far this year, more than any other State Street ETF.
Money market funds took in $30 billion last week, according to Refinitiv Lipper, while equity funds, taxable fixed income funds and tax-exempt bond funds all had net redemptions. Money market fund assets stood at $4.44 trillion at the end of August, not far from the all-time high of $4.67 trillion reached in May 2020, according to Lipper.
As bond yields climbed, equity valuations weakened. The S&P 500 is trading at a forward price-to-earnings ratio of around 16x, down from nearly 22x at the start of the year, according to Refinitiv Datastream.
“There was a lot of stimulus that helped companies when times were tough and when times were good the low interest rate environment drove valuations quite high,” said James Ragan, director of Wealth Management Research at DA Davidson. a resizing of that now.
Of course, stock alternatives are far from risk-free. Bonds, whose prices move inversely to yields, have endured a brutal 2022, with the ICE BofA US Treasury Index on course for its worst annual performance on record.
Many investors think bond prices are unlikely to stabilize until there is evidence of lower inflation and a pivot in the Fed’s tightening policy.
Investors holding cash, meanwhile, could be late for a potential stock market reversal.
Still, the robust returns will likely continue to present a challenge for stocks, investors said.
Fiduciary Trust Company has increased its recommended cash allocation in most of its portfolios to 12% from 2% at the start of the year, said Hans Olsen, chief investment officer of Fiduciary.
“There are things you can do now where you can actually get paid a reasonable amount of money to wait,” Olsen said. “I think that’s a big deal. It’s been a while since we’ve seen something like this and the markets are going to have to reprice that.”
(Reporting by Lewis Krauskopf in New York; Editing by Ira Iosebashvili and Josie Kao)
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