From TINA to TIARA
For much of the past decade, growing wealth has largely been about buying equities and staying invested. Central bank stimulus held cash and bond yields firmly below rates of inflation, while revenue growth from technology giants, falling tax burdens, and low borrowing costs supported stocks. It’s been a TINA market (There is no alternative).
But now we’re entering a TIARA market (There is a real alternative). This month’s bond sell-off pushed US real 10-year yields to a seven-year high, while US cash rates are within touching distance of inflation for the first time since 2008. The existence of lower-volatility alternatives to equities with positive real returns is now leading some investors to question if stock market volatility is still worth enduring.
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Enter the TIARA market
While we stress the importance of portfolio diversification and holding both equities and fixed income, at a tactical level investors are now faced with a decision between the two asset classes. Fixed income has become more attractive due to recent developments:
Improved return prospects for fixed income and cash
Potential risks stalking the equity market
Factors supporting equities look set to ebb
But we think stocks still hold relative appeal
Although a time for an overweight in bonds relative to equities comes in every cycle, we don’t think it is here yet due to the following factors:
The US remains in good shape
Economic data remains strong and is underpinning corporate profitability. Overall we expect 23-24% earnings per share growth (EPS) in 3Q. There is also little sign yet that rising rates are weighing on the US economy.
Lower valuations in Europe
European growth is not as robust as the US, but neither is it bad. Given the Eurozone’s much lower interest rates and bond yields, it offers an even more compelling valuation case than in the US. Current 10-year Bund yields are just 0.5% and the equity risk premium is 7.5% vs. a 4.5% long-run average.
Chinese stocks oversold
The Shanghai Composite is down 20% this year over concerns from trade and slowing growth. But Chinese authorities have often counteracted slowing growth effectively. In our upside risk case, we estimate 15-20% upside in Chinese stocks if the country's GDP manages to stabilize at 6.6-6.8%.
While our base case is that the trade dispute gets worse before it gets better, we cannot discount the possibility of US-China de-escalation. This scenario is unlikely in our view, but if it played out we would expect a US equity rally of around 5-10% and Chinese rally of 10-15%.
While there are now some attractive alternatives to equities, we do not consider them attractive enough to warrant underweighting stocks relative to fixed income. We therefore maintain our overweight position in global equities.
Within fixed income, we do continue to hold certain specific overweight positions, including an overweight position to 10-year US Treasuries vs. cash and an overweight to emerging market dollar-denominated sovereign bonds.
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