Relatively Speaking

It’s getting pretty stretched out there in equity land, notwithstanding stocks’ “relative” value versus bonds sporting ever-lower yields.

The persistence of this debate (the relative value discussion) is amusing. It’s almost as if it doesn’t occur to anyone that two things can both be expensive at the same time.

Of course, multi-asset investors are compelled to own something (you’re not really an investor if you’re not invested), so in a sense it’s always a relative value debate. But how many times can one have the same discussion and come to the same nonconclusions before the necessity of preserving one’s sanity dictates an abandonment of the argument and a throwing up of one’s hands?

There it is (figure above). The compensation for taking equity risk is (still) elevated, which means you can (still) make the argument for stocks versus bonds if you want.

And lots of people are — making the argument, that is. Or at least it appears that way, because investors plowed another $30 billion (almost) into US equities last week, EPFR said.

The latest haul just adds to the tsunami of money that flooded into stocks post-election (and post-vaccine readouts from Pfizer and Moderna). The $32.5 billion that poured into US equities in the week that captured the election results and the initial Pfizer readout was the second-most for a single week in history. Last week’s inflow was the fifth-largest.

The financial media is replete with clichés this weekend. But “cliché” needn’t be a pejorative. After all, overused expressions are very often apt, otherwise they wouldn’t be overused.

There’s talk of “FOMO” as investors worry that with the vaccine rollout proceeding and the Fed determined to keep financial conditions loose, stocks are a “sure bet.” And nobody wants to miss the party, even if a ticket costs the average worker more than ever when denominated in literal sweat.

“TINA,” that other clichéd acronym, found its way into weekend coverage, and that brings us right back to where we began. Cash gets you nothing. Bonds get you nothing (or less). Credit gets you something, but yields are at record lows, including junk.

Even CCCs yield the least in a half-dozen years.

For what it’s worth, nearly everything ended up working in 2020, so you needn’t have fretted too much. Gold still leads the pack (if you exclude Bitcoin and tech shares). But an idiot-proof S&P 500 index fund would have scored you 14% on top of last year’s 32%.

Emerging market equities have nearly caught up. Investment grade credit almost got you double-digits for a second consecutive year.

Closing the loop (i.e., circling back to the bonds versus stocks discussion), I think the debate is becoming less relevant over time. Developed market government bonds are administered assets. Central banks set the price.

That doesn’t mean there won’t be any excitement. Indeed, “tantrum” episodes observed in Treasurys, bunds, and JGBs over the past decade suggest that the odds of “fragility events,” so to speak, have increased. And, as we saw in March, even the deepest, most liquid market on the planet can “break.”

But you know what you’re getting when you allocate to Treasurys, bunds, or JGBs. You’re getting a low- or negative-yielding haven asset whose price is more or less determined by the Fed, the ECB, and the BoJ, respectively. The same is generally true of gilts and Aussie government bonds. When it comes to peripheral debt in the eurozone, it’s a funhouse market — which is exactly why the ECB is compelled to keep the morphine drip intact. You can’t allow the market to set the price for assets trading miles rich to anything that even approximates market clearing prices.

As for Treasurys’ role in a portfolio, calls for the demise of 60/40 on the assumption that yields “can’t go any lower” or, relatedly, that the negative correlation between stock and bond returns won’t be as reliable going forward, have a spotty track record. There is little in the way of concrete evidence to support a wholesale abandonment of the tenets underpinning 60/40.

Everything generally looks rich except for long-suffering pro-cyclical assets, and in case you haven’t noticed, they’re playing catch up pretty damn fast. Pretty soon, it’ll all be objectively expensive. And yet, the relative value discussions will invariably persist.