The Fed finally knocks equities off the asset allocation throne


(Bloomberg) — For years, asset allocators have had it easy: buy America’s biggest tech companies and watch the returns pile up.

Those days are over, buried in the rush of central bank rate hikes that rewrite the rules of the game for Wall Street investment managers. TINA – the mantra that investors had no alternative actions – gave way to a panoply of real choices. From money market funds to short-term bonds and floating rate notes, investors are now getting low-risk returns that in some cases exceed 4%.

The shift has been underway since the summer, but accelerated in September as investors accepted still-hot inflation data and a tight labor market that will force the Fed to set rates at the highest levels since March. housing crisis. After Chairman Jerome Powell’s comments on Wednesday, there is no doubt that the central bank is expecting at least a mild recession to rein in inflation.

“We have crossed the inflection point with bonds offering more value than equities, thanks to the pricing and realization of strong rate hikes, and the re-emergence of inflation risk premia in the bond market,” said Peter Chatwell, Global Head. trading macro strategies at Mizuho International Plc. “We expect downside earnings risks to make these equity risk premia even less generous in the months ahead.”

Not wanting to risk money in a stock market that, in a way, has been swinging wilder than ever since at least 1997. Investors are instead settling for two-year Treasuries that have been the most profitable since 2007. one-year bills fetch nearly as much, and while both lag recent inflation readings, it’s better than the 20% rout of the S&P 500 this year.

In total, fixed income securities have been the most profitable relative to equities for more than a decade. At just the right time, investors poured record amounts of money into short-term exchange-traded funds, while a record 62% of global fund managers are overweight cash, according to a Bank of America survey. They also reduced their equity exposure to an all-time low.

“Cash and short-term fixed income securities increasingly offer lower volatility and higher yield in a multi-asset portfolio,” wrote Andrew Sheets, Morgan Stanley’s chief multi-asset strategist, in an article. note. The new appeal of these alternatives is one of the reasons he recommends credit over equities.

Change is increasingly evident in the inflow and outflow of funds. Government bond ETFs garnered more inflows in September than their equity counterparts for only the second time in three years. Sovereign bonds now account for 22% of all ETF and mutual fund purchases over the past year, while equity allocations now stand at 2% over this period, according to Deutsche Bank AG.

The foundation for post-pandemic recovery – ultra-low interest rates and monetary stimulus – has crumbled. In its place are now high borrowing costs and tighter financial conditions that have forced investors into a cash-preserving mode.

This is evident even among those who are ready to get into the stock market. They favor companies with strong balance sheets and high dividend yields. Cash-rich companies continue to see strong inflows, take the Pacer US Cash Cows 100 ETF which saw only positive monthly inflows in 2022 totaling $6.7 billion year-to-date. Companies with stable income streams are also still attractive to investors with the $36 billion Schwab US Dividend Equity ETF which has received a cash injection of $10.6 billion so far this year.

The Fed’s aggressiveness has increased the threat of a recession and diminished the chances of a soft landing. This opens the door to longer dated bonds which will also become more attractive, especially if the Fed shows signs of slowing the pace of tightening.

“When rates peaked, it would make sense to move along the maturity curve in anticipation of lower bond yields,” said Chris Iggo, chief investment officer of core investments at AXA Investment Managers.

For HSBC’s chief multi-asset strategist Max Kettner, short-term bonds have become a better option than equities, but a clear shift from inflation concerns to growth concerns would trigger an even bigger move. broad towards fixed income securities. For now, HSBC’s strategy team led by Kettner has shifted to a larger overweight in cash and reduced equity exposure to a maximum underweight in August.

Even the “you only live once” day trading crowd was unable to take advantage of the stock declines.

“We are definitely seeing a regime change,” Kettner said. “The TINA and YOLO world of 2020/21 was basically brought to a screeching halt by the combination of slower growth and higher inflation.”

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