There were plenty of powerful investment storylines from the past decade…
We had the rise of the “FAANG” stocks, the painfully slow growth coming out of the financial crisis, and the global dominance of U.S. markets, just to name a few.
But if you were to sum up investor behavior from that period into a single idea, it’d be “TINA”… or “There Is No Alternative.”
This simple phrase describes a critical dynamic: When interest rates were at historic lows, investors had to buy stocks. There was no other way to make money. There was no alternative.
Fast-forward to today, though, and investors face a new reality. Interest rates have soared… which means assets like bonds can offer much higher yields.
In short, a new investment era just began… one where stocks have real competition.
You might think that in this environment, buying stocks isn’t worth the risk at all. But a closer look shows that this change might not be the death knell for the stock market that many expect.
Let me explain…
In the world of TINA, investment choices didn’t exist.
Most bonds paid close to zero percent interest. Your only hope of making money was for rates to fall further, leading to capital gains… But making a bet like that in bonds was about on par with risking money in the stock market.
In short, you couldn’t earn a safe yield anywhere. So investors poured into stocks.
Today, it’s a different world entirely. The 10-year Treasury yield is roughly 4.9% as I write. And that makes bonds a better deal than stocks for the first time in decades.
To see this, I compared the 10-year Treasury yield with the S&P 500 Index earnings yield…
The earnings yield is a simple way to measure the yield of stocks. You can find it by taking the inverse of the price-to-earnings (P/E) ratio… If stocks trade for a 20 P/E ratio, the earnings yield is 1/20, or 5%.
Stocks carry inherent risks… So, normally, the earnings yield should be higher than the 10-year Treasury yield. But the yield on long-term bonds recently surpassed the earnings yield on stocks for the first time since 2002. Take a look…
This chart shows the S&P 500 earnings yield minus the 10-year Treasury yield since 1963 – or the spread between the two.
A positive spread means stocks are cheap compared with bonds. And a negative spread means stocks are more expensive.
We’ve had a positive spread for the past 20 years. Now, with Treasury yields soaring, the regime has changed. Investors finally have an alternative to stocks.
You might think that’s a bad sign for the stock market. But history isn’t necessarily clear one way or the other…
The last time this spread went from positive to negative was in 1980. Markets were rocky for a couple of years after that. But then, a multidecade bull market kicked off.
Stocks soared nearly uninterrupted to their dot-com-boom peak… And the spread was negative practically the entire time.
However, the example before that shows the opposite…
The spread also turned negative in 1967. That was near the end of a major bull market. And the spread stayed negative nearly the whole time through 1973 – or darn close to the bottom of a painful bear market.
Here’s how we should read this signal: Major competition alone isn’t purely good or bad for stocks. What matters is the general state of the market.
Stocks do fine with some competition from bonds if the economy is healthy and fundamentals are strong. For now, the economy is still holding up better than anyone expected – even in the face of rising rates.
TINA might be dead. And a new investment era is just beginning. But that doesn’t mean stocks have to crash. Instead, the fundamentals say higher prices are likely from here.
Good investing,
Brett Eversole
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Source: DailyWealth