Wall Street and financial markets run on narratives. The unfortunate war in Ukraine and rising geopolitical tensions are adding to rising energy prices, further complicating the global inflation problem and the asset allocation question of stocks versus bonds.
While many stock markets turned negative for the year, Stock markets investors at the begging of April seem not too worried about rising US interest rates and their impact on equity market valuations.
The inflation inspired a surge in bond yields. Is leading global investors to revisit target allocations in the equities versus fixed income weightings in portfolios.
As on many occasions in recent years, the “there is no alternative” (TINA) investor mindset seems back in play as equities recovered the losses for the year.
Increasingly it seems, there are no alternatives to a globally diversified portfolio of equities, because bonds look toxic or at least offer return-free risk, and with inflation, cash looks toxic or sure to lose purchasing power.
Equities as an inflation hedge therefore increasingly seem the new market narrative, supporting equities as an asset class. Stocks are a real asset and dividends can grow over time with inflation.
This is based on the belief that equities as an asset class are among the best assets to hold in long-term investment and retirement portfolios when inflation &consumer prices are rising.
In an inflationary macro-economic environment, stocks have a distinct advantage over bonds – equities are linked to companies that can adjust pricing – whereas, in debt obligations like bonds or fixed income, this is not the case.
The global bond index is now the most oversold relative to its underlying trend in the past 20 years It is also notable that fixed income as an asset class has materially underperformed equities over the past month and quarter despite the drawdown in equities. While that might cause traditional multi-asset managers to rebalance out of equities into bonds, it highlights the existential problem of the inability of bonds to diversify equities in the current economic environment and interest rate cycle.
With cash holdings increasing and the bond market in a tailspin, investment choices seem to become more challenging. many asset allocators have reduced equities exposure given an excess of risks from an escalation of the war to rising inflation and higher interest rates.
There is an old saying in the stock market that you should be buying when they’re crying and selling when they’re yelling. The observation is clearly a contrarian statement about extremes in market sentiment, positioning, and investor beliefs. Recent price action in the bond market has been impulsive, rapid, and emotional and might offer some buying opportunities in fixed-income ETFs.
Recent price action in the stock market however seems to imply that the economy is not going to be unduly impacted by higher rates, global equities are relatively more attractive than bonds as the shift in market risk moves to inflation and economic growth.
A look at history, the 1970s and early ’80s inflationary period show signs of divergence.
US inflation ran at 159% during that period, while the home-prices index rose by the same amount. Yet the S&P 500 returned an aggregate of 169%, showing that corporate earnings can keep up with inflation even if macro growth and the economy weakens.
Wall Street analyst consensus views now see the S&P500 firms are expected to deliver another year of profit Expansions in 2022, due to their ability to pass on costs to customers. Over the past month, analysts have raised their 2022 profit estimates by more than 1% to $225.70 a share, according to Bloomberg data.
The bond market may be starting to send some warnings about global growth, but the prospect of a global recession further out is still less than 20%. Supporting the TINA argument.
Having said that, for most people, when the prices of things we need are going higher and the prices of things we want are going lower, “it creates economic misery.” Things we need include fossil fuels and agricultural commodities. Things we want may include stocks and bonds, in globally diversified investment portfolios.
In 2022, with stock and bond prices falling and commodity prices rising, wealth has been impacted, and the cost of living has increased.
As the unfortunate Ukraine conflict drags on, equities which turned negative for the year, recovered and found a bid because the Fed resolved to bring consumer prices under control, by raising interest rates.
News about a possible peace agreement between Russia and Ukraine could set up the equity market for a rally. the recent rally in the stock market may be due to technical factors given very low volumes and a lack of fundamental investor participation.
The Fed using forward guidance had set the scene concerning expected rates increases was welcomed by the equity market. S&P losses for the year have reduced or recovered from over minus -10% to -4.68%. and as of 28 March 2022, the largest equity market in the world is again positive year to date with 0.71% technically the S&P 500 index is now also back above the 200-day MA (moving average) yearly trendline.
The S&P 500 index is currently valued at 22.8 P/E with a market dividend yield of 1.36% this compares to the United States generic government 10-year yield of 2.5123% year-to-date, the best performing sector of the U.S stock market is ENERGY with a gain of +39.1%. As the cost of living for the average American has increased due to inflation, consumer discretionary with a year-to-date -of 14% is the worst-performing sector of the U.S. stock market.
While the Near-term global economy uncertainty remains high, dividend paying stocks and commodities and energy-related equities could continue to do well in various economic scenarios of the TINA narrative.
Rainer Michael Preiss serves as an investment advisor & portfolio strategist.
