Market Pulse: The end of TINA
June 11, 2018
It is almost certain that short-term interest rates will rise twice more this year (once this month) and then two or three times in 2019 unless something that would undermine the economy comes out of the blue.
What is known as the "end rate," which is where it will be when the cycle of raises ends, might be 3 percent, give or take a bit. Where longer-term rates will be then is of course unknown and depends on the outlook for inflation and credit demands at the time.
Investors for now do not see longer-term rates much higher, nor do I. Does that matter to stock investors? Yes, for two reasons. First, the present value of future earnings is inversely related to longer-term rates. The higher the rate, the lower the present value (read stock prices).
The second reason: When money-market funds and Treasury bills paid virtually nothing, stocks were clearly the best investment class. Those who coined the acronym TINA (There Is No Alternative) were correct that the expected returns from bills, bonds, commodities and gold paled compared to stocks. But that was then, this is now.
The three-month T-bill yields 1.95 percent today and by year-end it should be at least 2.5 percent. Money-market funds that yield 1.3 percent today will top 2 percent by year-end. The dividend yield on the S&P is less than 2 percent. So for the first time in years investors will have choices, and while other vehicles are not as attractive as quality stocks, they are becoming more so.
But, you ask, if short-term rates are rising and likely to continue why not wait for a better buying opportunity in bonds with higher yields? A fair question.
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The short answer is that longer-term yields, which are set by the marketplace, not the Fed, may not rise along with short-term rates. We've seen this several times over the last decade. Rates are hard to predict so don't commit a portfolio to just one possible outcome.
Bottom line: If long-term rates stay relatively low as I and many expect that would be good for stock valuations (the present value of earnings) and good because that would undermine the attractiveness of bonds and other vehicles. If rates rise more than most expect it would be because economic growth is robust and earnings would be growing faster, too, both reasons stocks would do well.
David Vomund is an Incline Village-based fee-only money manager. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.