Investors Have Never Been This Optimistic About Stocks Relative To Bonds
Authored by Ven Ram, Bloomberg strategist,
Never before have investors been this optimistic about stocks relative to bonds, a phenomenon that may have room to run before being upended by an economic downturn.
The net asset value per unit of the SPDR S&P 500 exchange-traded fund was $454.26 on Monday, more than five times that of iShares Treasury bond fund comprising residual maturities longer than 20 years.
That is the most elevated in their contiguous history spanning two decades.
The ratio has doubled since the end of the 2019, just before the pandemic struck, with the Federal Reserve’s 525 basis points of policy tightening since then wreaking havoc with bond valuations even as stocks have shrugged off the onslaught.
As of Monday’s close, the S&P 500 offered investors an earnings yield of just 19 basis points over 10-year Treasuries. That premium was negative as recently as last month, the lowest since 2002.
The melt-up in stocks is testament to their shrinking empirical durations in the current Fed tightening cycle. A few months into the cycle, stocks had demonstrated an empirical duration of 7.1 years, though the recent rally brought the S&P 500’s gain since the Fed started tightening to more than 6%. That means stocks have done enough to boast a negative duration — an asset that increases in value when interest rates rise.
Bonds, on the other hand, have copped it through this cycle. The Bloomberg Treasury total return index has incurred losses of about 9% since the Fed started raising rates.
Despite the recent rally in bonds, the outlook is still murky, with a host of factors weighing on sentiment: estimates that the neutral rate has risen considerably, a labor market where aggregate supply isn’t quite aligned with demand yet, and a disinflationary process that has further to run.
Interest-rate traders are betting that the Fed will start loosening policy around the middle of next year, but the resilience of the US economy has so far wrong-footed investors who have underpriced the policy trajectory through much of this cycle. Those factors explain why two-year Treasury yields have surged more than 100 basis points since the middle of the year to still hover around 5%.
While a chase for duration may have looked legitimate this late in the Fed’s tightening cycle, a surge in real yields has come back to haunt both 10- and 30-year bonds. Should that narrative continue to bedevil the markets, sentiment toward longer-dated maturities may stay subdued.
A turning point in investors’ attitude toward bonds relative to stocks will occur when we see an inflection point in the US economy. However, with the jobless rate still below 4%, a rebalancing of the economy is still not in sight, which may preserve the skew between the two asset classes.