By Tim Courtney, Chief Investment Officer
For most of the past decade, many investment rationales have been ruled by the mantra, “There Is No Alternative,” commonly abbreviated to “TINA.” This acronym refers to years of ultra-low interest rates that left investors with few viable options outside of stocks. With inflation at 1.5% to 2.0%1 and bond yields hovering around 2%2, much of the fixed income market offered a real return close to 0% after taxes. For growth, investors looked to stocks that provided profits and potential growth.
In 2022, however, things changed. The Fed’s stimulative policies were reversed as the central bank began raising interest rates. Almost immediately, the asset price surge that had run from March 2020 through the end of 2021 began to reverse due to those rising rates and the increased cost for investors to borrow and use the proceeds to buy real estate, stocks, start-up companies, etc.
We are entering 2023 with a new investment landscape. Instead of getting 1-2% yield on bonds, investors closed out 2022 with many bonds offering a 3.5% to 4.5% yield3. While still lower than the rate of inflation, bonds have become more attractive than they were. In addition, these higher rates mean that stocks now have some competition and that “TINA” may be on hold.
What does this mean for markets?
Higher bond yields have been a healthy thing for investors and markets. When bonds weren’t an effective option for many investors the prices of other assets became distorted. The resetting of interest rates has led to market pricing that is more influenced by profitability and productivity. These are the fundamentals of investing and are why we invest.
In seeing what has happened to some companies and assets since interest rates have moved higher, we’re reminded of a quote from Warren Buffet, “Only when the tide goes out do you discover who’s been swimming naked.”4 As it turned out, several assets and companies were skinny dipping. Now that bonds are paying more, investors are willing to pull capital from speculative assets and place them into bonds. That keeps stock prices more honest – a good thing.
Another good thing is that expected returns for bonds have moved higher, along with higher rates. And because stock valuations have come back closer to their longer-term averages, we have slightly raised our long-term expected returns for stocks as well. We believe both stock and bond investors should ultimately receive benefits from this move higher in rates.
Of course, risks remain in the market — primarily inflation, even higher rates, and a potential recession. We think we are close to the end of the Fed’s rate increases and that the market is already priced for a mild recession. The market is also priced to expect rate cuts later this year. Here’s to rooting for rates that don’t fall too much though — it’s good to once again have bonds with a yield and stocks that are kept honest by viable alternatives. If you have any questions about your portfolio, please contact your Exencial Advisor.
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