The fixed-income market’s unblemished record of striking fear into the hearts of equity traders is in danger.
With rates on two- and 10-year Treasuries up a sixth straight week, and payouts on cash at or above the earnings yield of the S&P 500, stock investors are barely registering a shrug. Benchmark US share indexes just posted their biggest runup in a month, climaxing Friday with a jump in the Nasdaq 100 that topped any since early February.
Why peace is breaking out in risky assets during a week that at one point saw yields in the entire Treasury market rise above 4% is a mystery Wall Street has no easy answer for. Charts may be one reason: the S&P 500 bounced sharply after falling below its 200-day average on Wednesday. Another may be that investors are interpreting elevated rates as a sign strong economic data is likely to persist, says Chris Zaccarelli at Independent Advisor Alliance LLC.
“It’s interesting to see stocks whistling past the graveyard,” Zaccarelli said. “Stock investors may be looking for yields to drop as a sign we are going to have a recession and are seeing an all-clear in the sense that rates are higher.”
The indifference to calamity on display in stocks was particularly vivid as the week ended. Friday’s 1.6% gain in the S&P 500 pushed the Cboe Volatility Index below 19, testing lows hit when equities surged at the start of the year. A basket of most-shorted stocks rose 3.2% — it’s fifth straight advance — while a gauge of unprofitable technology companies vaulted almost 6%.
It’s happening even as money cascades out of stock-focused ETFs and into fixed-income funds, as risk-free yields reach multi-year highs. Short-dated Treasury bills are enticing investors as yields push above 5%, eclipsing the payout on everything from profits generated by S&P 500 companies to those offered by the traditional 60/40 portfolio of stocks and bonds.
But while the trade is touted as risk free, it comes with opportunity costs. Grasping for a 5% yield right in an S&P 500 bear market strikes certain money managers as an iffy proposition.
“That short rate isn’t going to be at those levels forever — it’s probably going to end up lower,” said Robert Tipp, chief investment strategist at PGIM Fixed Income. “What we’ve seen over long periods of time is that the long-term assets outperform cash. And we have every reason to believe that’s going to be the case.”
Over the past year, the SPDR Bloomberg 1-3 Month T-Bill exchange-traded fund (ticker BIL) has returned about 2%, while the SPDR S&P 500 ETF Trust (SPY) has dropped 6.3% on a total return basis. However, over the past decade BIL is flat, while SPY soared 165% during an epic bull run.
“There’s much less ‘opportunity cost’ than what we’re used to because it’s a place where you can get paid while you wait, but there’s not long-term price potential like in equities,” said Liz Young, head of investment strategy at SoFi. “So for people with more than a five-year time horizon, you still need equities in the portfolio to set you up for compounding returns.”
The notion that yields may be peaking also has investors preaching caution when it comes to bonds. While bets have been building in recent weeks that the Fed will ultimately need to raise rates past 5% to stamp out inflation — boosting yields across the Treasury curve — traders are pricing in an end to increases by September.
Tipp hearkened back to the 1970s, when inflation was a threat to both stocks and bonds. As growth moderated and rates leveled off and then came down, equities rose — even though the economy remained weak.
“There’s a good chance that that kind of cyclicality is going to make its way through the markets, and people that lock in at the short term, exit the long-term markets and go into short term are going to suffer,” he said. “Their long-term returns are not going to be as high because the cash rates will probably move lower.”
Analysts say that the haven appeal of cash-like positions combined with reliable returns means investors have an attractive place to wait out any turbulence induced by the Fed’s path.
“I do think that we need to take advantage of the higher yields on the short-end of the yield curve, wait out this continued volatility,” David Spika, president and chief investment officer of GuideStone Capital Management, said in an interview. “And then at some point we’ll hit a bottom, and that will be a great time to re-risk, take that money out of cash, put it back in equities and you’ll benefit from that.”
Six-month Treasury bills currently yield about 5.1%, the highest since 2007, compared to the S&P 500’s earnings yield of roughly 5.3%. That’s the slimmest advantage for stocks since 2001.
Though bonds look attractive at current yields relative to equities, the risk investors are taking in allocating to cash is the uncertainty of that yield going forward, said Josh Emanuel, chief investment officer at Wilshire, which oversees roughly $90 billion.
“So, cash may pay you 4.5-5% today, but in one year that may not be the case, in two years that may not be the case,” he said in an interview. “The challenge in allocating to cash is that while you’re not taking any duration risk and you’re not taking any credit risk, the risk that you’re taking is the opportunity cost or the uncertainty risk associated with what that cash will pay you in the future relative to the yield you can lock in over the longer-term by moving out further on the yield curve.”
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