Rick Rieder, BlackRock Inc.’s chief investment officer of global fixed income and head of the global allocation team, sees individual investors who allocate 60% to stocks and 40% to bonds coming to the same conclusion. “For a traditional 60-40, if a lot of the 40 is getting you zero to negative return, holding more cash and moving more to equities or private, less-liquid alternatives, that’s going to keep going,” he said in an interview. “The yields we’re financing companies at today is not a normalized condition. Part of why I think equities will continue to run higher is it’s allowing companies to spend on capex, M&A, R&D — it’s just a direct injection of enterprise value for these companies with where they can borrow.”
If that weren’t enough, none other than Fed Chairman Jerome Powell appeared to make the case that stocks aren’t as inflated as they seem by employing the so-called Fed model, which looks at the S&P 500’s earnings yield relative to bonds. He also made it clear that investors shouldn’t expect meaningfully higher long-term interest rates anytime soon.
“Admittedly P/Es are high, but that’s maybe not as relevant in a world where we think the 10-year Treasury is going to be lower than it’s been historically from a return perspective,” he said during his Dec. 16 press conference.
He might as well have said TINA (there is no alternative). “As much as the Fed says they don’t focus on the stock market, we know that they do,” and the comment on equity valuations proved it, said Patrick Leary, senior trader and chief market strategist at Incapital.
At some point, once the cloud hanging over the U.S. economy from the pandemic is lifted, the Fed will most likely pay closer attention to financial conditions, which are as easy as they’ve ever been. “By lowering the discounting rate for every asset class, you’ve inflated the terminal value of those asset classes,” Bob Michele, global head of fixed income at J.P. Morgan Asset Management, told me. “That’s something that longer term is not sustainable, and you need a response.”
That doesn’t help bond investors heading into 2021, however. A slow and steady increase in 10-year Treasury yields from 0.9% to 1.25% — as predicted by Goldman Sachs Group Inc. — would mean a loss of about 1.6%. For General Electric Co. debt that matures in 2035, the largest component of the Bloomberg Barclays triple-B corporate bond index, it would only take a 30-basis-point move higher in yields by this time next year to produce a negative return. If yields are unchanged, it would return 2.9%. But to Maroutsos’s point, that compares with the 13.3% gain for the S&P 500 since the end of October.
Stocks don’t “always go up” and certainly shouldn’t be seen as providing risk-free returns. But, as some market observers like hedge-fund billionaire Leon Cooperman have taken to saying, bonds at these yields offer something closer to “return-free risk.” When faced with those two options, it’s hardly surprising that investors are leaning toward riding the equity rally into the New Year. Even the “smart money” in fixed income.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.