“There’s No Alternative” – The long-term “TINA” advantage in stocks could end and worry traders
The New York Stock Exchange (NYSE) stands in the financial district of Manhattan in New York City on January 28, 2021.
Spencer Platt | Getty Images
Will March be the death of the “TINA” trade?
February started with reflation trading and ended with a bond market that upset stock valuations and caused some to wonder if this is the end of the fabled phrase “there is no alternative” to the concept of stocks.
The reflation trade: will it take?
With the S&P 500 up 2% in February, all outperformers in the sector are tied to reflation trading – sectors that will benefit from the reopening of the US and global economies.
Reflation trading in February
- Energy increased by 24%
- Banks up 19%
- Industrials up 8%
- Materials increased by 5%
At the same time, defensive sectors that are not considered cyclical have lagged the markets.
Defensive sectors in February
- Consumer staples were flat
- Health care down 2%
- Utilities down 5%
The end of TINA?
The story behind the reflation trade is still intact: the pace of vaccination is accelerating, the reopening of the US economy is picking up pace, there is a “go big” incentive, and profit estimates for 2021 have risen.
But a new cloud is looming: higher bond yields limit highly valued stocks.
“There is no alternative to stocks” (TINA) has become a bull’s mantra, arguing that returns were so low that bonds were barely worth owning as an asset class.
That could change now, says Savita Subramanian of Bank of America: “Income investors forced into stocks because of tight returns may be more likely to revert to traditional fixed income assets, and history hits 1.75% (house forecast) for the 10th – before. yr is the tipping point where asset allocators turn back into bonds. “
Which stocks will hurt when interest rates go up?
Unsurprisingly, Subramanian says the sector that does best when rates are rising is financials. The sectors that tend to perform worse are defensive: consumer staples, healthcare, utilities, and real estate.
This is exactly how the market reacts. When interest rates rose in February, banks rose and defensive stocks fell.
Another group hurt by rising interest rates are technology stocks, and with good reason Subramanian notes: “Extremely low interest rates have skyrocketed valuations for secular growth stocks since the financial crisis,” she says.
Unsurprisingly, megacap tech stocks went down as soon as rates rose.
Megacap Tech in February
- Apple down 8%
- Xilinx down 4%
- AMD down 4%
- Facebook down 4%
- Microsoft down 1%
The three factors that determine stock prices
The Federal Reserve was furiously pumping money into the economy, and much of that money made its way into the stock market and was a big part of why stocks have done so well over the past year.
While “liquidity” (how much money is available to buy and sell stocks) is an important factor, stocks have traditionally risen due to a combination of the following:
- An increase in dividends;
- An increase in income; or
- An extension of the P / E multiple.
Vanguard founder Jack Bogle referred to dividends and profits as the “fundamental” part of stock investing, while stock increases due to the growing P / E ratio were referred to as the “speculative” part of the market, meaning investors betting on whether profits are possible in the future will rise.
Much of the recent hike in stock prices can be attributed to a widening of the P / E ratio, which is now roughly 22x its 2021 profit.
Especially for big-cap technology stocks, the P / E ratio rose dramatically in 2020. The chip manufacturer Xilinx, for example, rose from 25 to 50 times its profit on time. NVIDIA rose from 30 to 60. Even old-school big-cap tech stocks saw their P / E spikes sharply over the past year, with Microsoft climbing from 25 to 35 and Apple jumping from 20 to 35.
These multipliers have decreased when interest rates increased in 2021.
The bad news is that even if bond yields don’t move higher, the current surge is a cap on valuations.
If interest rates keep rising, can stocks go up?
If higher interest rates actually cap stock multiples, then investors will have to rely on dividend hikes and actual rising profits (not just expectations) to drive prices up.
Fortunately, there is good evidence that this is happening. Analysts have repeatedly underestimated the strength of the economic recovery. Earnings estimates for the S&P 500 for the first quarter of 2021 rose from 16.0% to 21.6% from January 1 to February 26, and earnings estimates for the second quarter rose from 45.7 to 50, 9% increased over the same period.
With rates unclear, expect March to be volatile
It’s a two-way battle between the bulls who say the markets can handle higher interest rates and those who say valuations are still too high and between those who say the Fed is in danger to lose control of the low-interest narrative.
Jim Paulsen von Leuthold was a constant bull in the debate about interest rates and stocks. “How [Fed Chair Jerome] Powell just said a major reason bond yields are soaring is because “real economic growth” (and EPS) is recovering intelligently, “he told me in an email.” Is a 40 basis point increase in real return really that worrying? Given the surge in EPS estimates almost back to record highs in 2021? “
The Federal Reserve ranks above every investor. Many believe the Fed will likely come under pressure towards the end of this year to reduce its bond purchases.
This would continue to weigh on stock prices, but the way it is handled could mean the difference between moving sideways and falling sharply in markets.
“If the market starts to believe that the Fed has lost control and the Fed senses this, there is a chance the Fed is overreacting, so we are in a very potentially volatile phase,” UBS’s Art Cashin said on our broadcast .
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