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Good morning. US stocks managed to stay roughly flat yesterday, even as bond yields continued their ascent. Today, we ask how long this can go on. Send us your thoughts: [email protected] and [email protected].
Will the world reallocate to bonds?
Sometimes it’s useful to ask a dumb question. So here’s one: why would you buy equities right now, when 6-month Treasuries are paying more than 5 per cent?
Yes, 5.2 per cent is a flat-to-negative real return, depending on how you measure inflation. But you’re not going backwards. If you think inflation is near is a peak, you can extend your maturity, give up a little yield, and hope for a capital gain. If you think inflation could keep rising, buy the 6-month and roll it into something higher in September. And remember, as yields rise, the damage done to bond returns by further rate increases diminishes: the coupon is a natural insulator.
Stocks, meanwhile, are still expensive by historical standards, at a moment of slowing sales, tightening margins, falling earnings and high volatility. Why not cut some risk, take the yield, and chill until autumn?
My friend and former colleague James Mackintosh made the case neatly in the Wall Street Journal this week:
The central lesson of financial history is that, over the long run, US stocks beat bonds. But buying stocks when they are expensive — at 18 times estimated earnings for the next 12 months, they have rarely been pricier outside the dotcom bubble and the post-pandemic boom — is a recipe for substandard returns. At the same time, Treasury yields are back up to decent levels. There’s plenty of scope for bonds to disappoint if inflation turns out to be endemic. But at least they start out at a reasonable valuation, based on current yields.
Here’s a closely related, and perhaps slightly less-stupid, question. Will bonds’ attractive valuation relative to stocks lure capital out of stocks and into bonds — putting pressure on those high stock prices?
ETF flows suggest there may be a sell stocks/buy bonds trade among passive investors. In a recent note titled “Will 5% yields slow equity ETF growth?” Strategas’ Todd Sohn noted that:
. . . equity ETF flows remain tepid. There’s still a day to go, but February flows are probing their lowest intake since April 2022 . . . equity market nerves plus 5 per cent short-term yields has inflows to cash-like bond ETFs posting a record $8.6bn surge over the last five trading days. Safe-haven appetite pairs off with sharp outflows from high yield and the aforementioned reluctant broader equity flows
Sohn told me that lately there does seem to be at least a loose correlation between Treasury ETF flows and 6-month yields. His data, my chart:
Parag Thatte’s strategy team at Deutsche Bank says their measure of aggregate global equity positioning fell the most in three months last week, as equity funds had outflows, especially in the US. Their map of the level and momentum of fund flows puts short, intermediate, and blended bond funds all in the “high and rising” quadrant:
Unhedged’s regular interlocutor Ed Al-Hussainy of Columbia Threadneedle makes the important point that there is one large class of investors that will definitely be rebalancing from equity to bonds, because they have to: defined-benefit pension funds. The recent increase in rates has reduced the present value of the pension funds’ liabilities, leaving US funds 9 per cent overfunded, according to the Milliman index. Fund mandates will force them to reduce equity risk and lock in returns using bonds. This will be a global phenomena.
The relationship between flows and asset prices is complex, and theoretically contested. It is also not clear — to me at least — what proportion of global financial assets are held under mandates that allow for significant shifts in allocation between asset classes. But if rates stay higher for longer, it seems logical to assume that this will be a headwind for equities.
Could an activist investor make money in Goldman Sachs?
Yesterday, on the heels of Goldman’s rather unsuccessful investor day, I wrote that Goldman was just sort of boring, and its best strategic alternative was to become more boring. By this I just meant that, as I have argued before, the bank’s strengths are in businesses that investors just don’t like much, but attempts at diversification do not make loads of sense, so it should just learn to live with a low valuation.
But conversations yesterday with some close observers of the bank make me think there might — might — be some fixes that an activist could press for and make a buck or two, while boosting the bank’s valuation on behalf of all investors. These fixes fall into three buckets:
Remove ambiguity about the future of the businesses that are not working. CEO David Solomon said the other day that “we’ve significantly narrowed our ambitions for our consumer strategy, and . . . we’re also considering strategic alternatives for our consumer platforms.” But he might have said “We’re looking for a buyer for GreenSky, we’re getting out of the Apple card partnership, and while Marcus is a nice deposit-gathering platform, we’re just not a consumer lender so we are getting clear of that side of the business, too.” That would have demonstrated a commitment to getting back to basics and returned focus to what Goldman is good at.
Re-emphasise operational efficiency and agility. Goldman has added 12,000 employees since year-end 2018, an increase of a third. As a result, even as revenue has boomed, there has been little operating leverage on pay costs. This is bad, and Solomon has said as much. But investors need more proof that operations are a priority.
Restoration of Goldman Sachs’ culture. This is a polite way to say “move on from Solomon”. The DJing, the chatter about private jets, the complaints to the press by partners and alumni about lack of focus and respect for the institution all have to stop. Goldman’s biggest asset is its reputation as a kind of monastery of pure capitalism.
None of this would be easy or costless. Telling the world you are going to sell something before you sell it puts you in a difficult negotiating position. Telling employees that headcount is coming way down does not boost morale. And the fact is that under Solomon, the bank’s core businesses — trading and advisory — have taken market share. Everyone beats Solomon’s Goldman to death because its shares have badly underperformed Morgan Stanley’s. Less noted is the fact that it has outperformed Bank of America, JPMorgan Chase and the S&P 500.
An activist might make money in Goldman, but I have to think there must be softer targets out there.
One good read
FT journalists in The New Yorker!