Sea Change?

Who needs bonds when there’s stocks?

In fact, who needs anything when there’s stocks?

Humorous questions, both. But they’re being taken all too seriously these days, as tales of Robinhood riches (never mind who’s seeing your order flow) make the national news and US indices seemingly hit new record highs with each passing session.

It doesn’t help that cash yields are zero. Of course, that’s nothing new. But it gets old. Cash was among the best performing assets in 2018, but that wasn’t saying much. 1.8% counted as “good” that year. The simple figure (below), is pretty depressing for the most risk-averse among you.

Do you remember what it’s like to get 5% on cash? How about 6%? It seems laughable now — a fanciful, ridiculous pipe dream.

The figure also shows how hard 2021 has been on US Treasurys. One key benchmark fell into a bear market last month. The drawdown (~22%) was the worst ever.

Between “TINA,” “FOMO” and the prospect of further turbulence in bonds, equity inflows have been robust, to say the least. As discussed here on Saturday, another $25.6 billion flowed into global equity funds in the latest weekly reporting period, bringing the YTD total to $413 billion. Over five months, the figure is more than $600 billion.

In March, we may have witnessed a sea change. “Besides enriching Reddit traders and making the stock market front-page news again, the world’s cultural obsession with risk-on assets is doing something that has almost never happened in the past three decades; turning bonds into an also-ran,” Bloomberg’s Lu Wang wrote, in a weekend piece, calling the disparity between equity and bond inflows in March a “stark display of changing tastes.”

The figure (below), is based on ICI data and shows stock inflows outpacing the monthly haul for bonds by some $20 billion.

The tide may already be turning, though. Or perhaps it’s more accurate to say that bonds were due for a reprieve. Last week was all about the juxtaposition between a rally in duration and scorching-hot US economic data. Bonds had every reason to extend Q1’s rout. Instead, yields dropped, sending market participants on a quest for answers.

That, even as the whole episode had a kind of “if a tree falls in the forest” feel to it. A week ago, I colorfully described a dearth of activity and interest. “Markets felt like the handful of people loitering around the monitors might have washed down a couple of Xanax with a swig of vodka,” I ventured.

Fast forward a week and folks were still enjoying that blissful spring somnolence. Or at least equities folk. “The calm across equity markets has coincided with a drop in trading activity,” Goldman’s David Kostin said Friday, noting that S&P 500 average trading volume as a share of market cap in April “has registered as the lowest since January 2020.”

Waning enthusiasm among retail investors is at least partially responsible. Although Kostin noted that daily average traders at online retail brokers are still up 75% YoY, “the growth in trading has dropped sharply from the peak of 250% in August 2020 [and] total US equity call option volumes have dropped to their lowest level since late [last year], albeit at still elevated levels by historical standards.”

That may suggest that some of the dynamics behind piqued (and peak) public interest are set to ebb. Equities could keep rallying, but the the frenzied mood fostered in part by headlines touting Tesla, GameStop, SPACs and other manifestations of froth, may give way to something slightly more rational, as irrational market participants return to day jobs or make their way to beaches and bars. The “stimmy” bid started to go missing late last month.

So, perhaps the “sea change” mentioned above was a head fake. The same linked Bloomberg article readily admits that precedent is pretty daunting (the figure, below, gives you some context).

“The newfound affection for stocks is a departure from the past decade where investors funneled money to fixed income,” Lu Wang went on to say, adding that “the about-face follows the S&P 500’s biggest 12-month rally since the 1930s.”

That kind of trajectory generally isn’t sustainable. It’s not that stocks can’t keep moving higher, it’s just that the pace of gains is virtually guaranteed to moderate.

Rallying ~80% over 12 months after one of the most violent plunges in recorded history is one thing. There’s a thin line between panic and greed, after all.

Rallying another 80% on top of that would be akin to suggesting that because I increased my bench press from 175 pounds last year to 275 pounds today, it makes sense to say that within five years, I’ll be benching 800 pounds.