Co-Heads of Investments Ben Kirby and Jeff Klingelhofer discuss whether bonds are more attractive than equities and more attractive than cash instruments.
Observations: Is Cash the Place to Be? We Don’t Think So.
Adam Sparkman: So Ben, both in the U.S. and Europe, core inflation has been persistent and remains stubbornly above that 2-percent target, that central banks have set. Do you think that we may be in a higher-for-longer interest-rate environment? And if so, what do you think the potential implications are for equities?
Ben Kirby: I think base case is that rates need to be higher in the next 10 years than they were in the last 10 years and that’s gonna be driven by, higher inflation but also realization that zero-interest rates, was maybe a bad idea, in the first place. What that means for equities is that the discount rate you need to use, as you think about discounting your equity valuation is gonna be a higher rate, which inversely means a lower equity valuation. So, I think about, comparing equity valuations, on an equity-risk-premium basis to fixed income on an inflation-adjusted basis. So, think about tips, which are gonna give you a real rate of return of about 2 percent, today, with a 10-year duration. That’s actually really attractive. Compare that to the S&P 500, at an 18-and-a-half PE, if you wanna invert that, that’s about a 5-and-a-half percent, equity-risk premium, subtracting out the 2 percent, you’re at 3-and-a-half percent, which is historically, relatively low, which to me argues that, bonds look a bit more attractive than stocks today, at least at the headline level. There’s a lot of places under the headline that you can find some really interesting, equity-valuations today but at the index level, bonds look pretty attractive.
Adam Sparkman: Jeff, so we have money-market funds, treasury bills and CDs, yield-surging, as the Fed has tightened rates through this cycle. Is it prudent for investors to park their funds into these vehicles, or do you think that fixed income, perhaps, offers a better alternative?
Jeff Klingelhofer: I think what the real of the answer, to that question, comes down to, what are you trying to accomplish? I think the reason why most investors are moving into money-market funds is because they’re scared. It’s a way to put, hang out and just wait to see what happens.
I would say, just recently, what we’ve seen is money-market funds have actually stayed the front end of the yield curve, or stayed relative constant. We’ve seen the back end of the yield curve actually come up quite a bit. Right, so, we’ve seen a little bit more steepness in the yield curve, a little bit closer to traditional and normal. I think, regardless, we’ve seen such a tremendous rise in the broad level of yields, that now is the time to play safety, right. Coming out of a very low period of interest rates as, as we’ve talked about, we don’t think that’s likely to continue, indefinitely and obviously it’s reversed thus far.
But what we do think is we’re reverting back to a more historically normal environment where if we do the recession come through, we will see yields fall, and you’ll get an outright positive return on very high-quality fixed income if you have a little bit longer duration. So we think now is the time to take advantage of that move. We continue to think the sweet spot of duration is somewhere between 3, 4, years because that, that takes advantage of one, yes, higher income in the front of the yield curve and of course there is always the right tail of risk of continued higher inflation, where the Federal Reserve and central banks have to, have the world have to move more aggressively. So we like that 3 to 4 year part of the yield curve in particular but now is the time investors should be moving.
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