For years, asset allocators had it easy: Buy the biggest American tech companies and watch the returns rack up.
Those days are gone, buried under a crush of central bank rate hikes that are rewriting the playbooks for investment managers across Wall Street. TINA -- the mantra that investors had no alternatives stocks -- has given way to a panoply of actual choices. From money market funds to short-dated bonds and floating-rate notes, investors are now locking in low-risk returns that, in some cases, exceed 4%.
The change has been underway since the summer, but picked up speed in September as investors came to terms with still-hot inflation data and a tight labor market that will force the Fed to pin rates at the highest levels since the housing crisis. After Chair Jerome Powell’s comments Wednesday, there’s little doubt the central bank expects at least a mild recession to curb inflation.
“We have gone through the inflection point of bonds offering more value than equities, thanks to the pricing in and delivery of large rate hikes, and a re-emergence of inflation risk premia in the bond market,” said Peter Chatwell, head of global macro strategies trading at Mizuho International Plc. “We would expect the earnings downside risks to make those equity risk premia even less generous in the coming months.”
Unwilling to risk cash in a stock market that, by one measure, is swinging more wildly than any time since at least 1997. Investors are instead settling for two-year Treasuries yielding the most since 2007. One-year notes pay out nearly as much, and while both are trailing the latest inflation readings, it’s better than the 20% rout in the S&P 500 this year.
All told, fixed income is yielding the biggest rewards relative to equities in more than a decade. Right on cue, investors have been pouring record sums of money into short-duration exchange-traded funds while a record of 62% of global fund managers are overweight cash, according to a Bank of America survey. They have also reduced their exposure to stocks to an all-time low.
“Cash and short-term fixed income increasingly offer lower volatility and high yield within a cross-asset portfolio,” Morgan Stanley’s chief cross-asset strategist, Andrew Sheets, wrote in a note. The new appeal of those alternatives is one reason he recommends credit over equities.
The shift is increasingly showing up in flows into and out of funds. Government bond ETFs have gathered more inflows in September than their equities counterparts for just the second instance in three years. Sovereign bonds now account for 22% of all ETF and mutual fund buys over the past year, while allocations to stocks now net out to 2% in that time, according to Deutsche Bank AG.
The foundation of the post-pandemic rally -- ultra-low interest rates and monetary stimulus -- has crumbled. In its place now stand elevated borrowing costs and tighter financial conditions that have forced investors into cash-preservation mode.
That’s evident even among those willing to wade into the stock market. They are favoring companies with strong balance sheets and high-dividend yields. Cash-rich companies continue to see strong inflows, take the Pacer US Cash Cows 100 ETF which has seen only positive monthly inflows in 2022 totaling $6.7 billion year-to-date. Companies with steady income streams are also still attractive for investors with the $36 billion Schwab US Dividend Equity ETF getting a $10.6 billion cash injection so far this year.
The Fed’s aggressive hawkishness has increased the threat of recession and diminished the odds of soft landing. That opens the door for longer-dated bonds to soon become more attractive too, especially if the Fed shows signs of slowing the pace of tightening.
“When rates have peaked, it would make sense to move out along the maturity curve in anticipation of bond yields coming down,” said Chris Iggo, chief investment officer of core investments at AXA Investment Managers.
For HSBC’s chief multi-asset strategist Max Kettner, short-duration bonds have become a better option than equities but a clear shift from inflation worries to growth concerns would be the trigger for an even broader move to fixed income. For now, the HSBC strategy team led by Kettner has moved to bigger overweight position in cash and cut equity exposure to maximum underweight in August.
Even the “you only live once” day trading crowd hasn’t been able to profit from any equity dips.
“We are definitely seeing a regime shift,” Kettner said. “The TINA and YOLO world of 2020/21 has been basically brought to an abrupt halt by the combination of slower growth and higher inflation.”
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