By Michael Msika, Bloomberg markets live commentator and reporter
For more than a decade, equities have held greater attractions to investors than bonds and credit thanks to strong earnings and high dividend yields while bond yields were extremely low. Fast rising interest rates and growing risks to profits are quickly changing this paradigm.
TINA (There Is No Alternative) to equities has been a long-held mantra to justify a high exposure to stocks, as ultra-low borrowing costs in the aftermath of the global financial crisis kept a lid on fixed-income returns. Now the market expects US interest rates to exceed 3.5% by the end of the year, while the European Central Bank is set to start raising rates in July, following the path of the Bank of England and the Swiss National Bank.
“The lack of alternatives, or TINA, has been a key reason for the divergence in flows year-to-date between fixed income and equities, with equities benefiting from their inflation hedge status,” according to Barclays strategists including Emmanuel Cau, who say that argument now faces an “earnings risk.”
The strategists say rates volatility should keep credit and stocks on edge, with a scenario of elevated inflation and low growth favoring the former over the latter, and investment grade over high yield. Consequently, for equity investors, shares with high credit ratings are preferred to those with low ones, they say.
According to EPFR data, while stocks suffered some outflows in the past few weeks, about $195 billion poured into the asset class this year, compared with nearly $151 billion of outflows from fixed-income strategies.
While bond yields are soaring, spurred by sticky inflation, interest-rate hikes and tightening monetary policy, dividend yields are now at risk as the chance of a recession grows and margins are pressured by rising costs.
Amundi’s Chief Investment Officer Vincent Mortier and strategist Monica Defend remain cautious on developed-market stocks, especially in Europe, saying the earnings outlook is still “too optimistic,” and “the risk is to the downside.” By contrast, the recent bond selloff makes fixed income “selectively more attractive,” as central-bank hawkishness is now priced in, they say.
“Yes, bonds are getting increasingly attractive relative to equities — however from a low base,” says Mathieu Racheter, head of equity strategy at Julius Baer. “You’re still losing money on an inflation-adjusted basis with IG bonds.”
Racheter sees the current environment as a stock pickers’ market, and recommends focusing on companies with high cash flow yield and stable earnings, something to be found in the Swiss equity market. “TINA is over, but equities still remains our favorite asset class,” he says.