Bonds over stocks?


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

  • US 10-year bond yields hit 3.25% at one point this month
  • US cash rates are on track to be close to 3% by the end of next year

Potential risks stalking the equity market

  • Accelerated Fed tightening
  • Global trade war
  • A sharp slowdown in China
  • Oil supply shock

Factors supporting equities look set to ebb

  • Central banks in aggregate will be shrinking rather than growing balance sheets from November onward
  • US tax cuts will soon stop having an incremental positive impact on the US economy and profits
  • Enacted tariffs could start to impact US and Chinese economies
  • Global growth overall will slow in 2019 vs. 2018

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%.

Trade upside

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%.

Investment conclusion

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.

See the preferences tab for our full list of asset class recommendations.

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