“Humans are exceptionally adaptable. Investors will adapt to the new rate environment rapidly, if they haven’t already. Many individuals and large pools of capital alike have likely already shifted from stocks into money market funds and bonds yielding 5%.”
Is this empirically true? We entered ZIRP policy in 2009 but it took several years (during which first derivative on rates was zero) for investors to appreciate what that should mean for equity multiples.
As for investors rotating into bonds, most of the charts I see still show equity allocations as percent of overall portfolio near/at all-time highs. (Obviously that’s tough because m2m impacts if, so maybe inflows/outflows are better metric, but haven’t seen/heard about huge equity fund outflows and bond fund inflows.)
The alternative is that investors are too slow to adapt to a new regime. First the market was pricing in rate cuts before “higher for longer” set in. Then the belly / long end of the curve finally moved up. Presumably the next shoe to drop would be equity risk premia increasing.
With that said I’ve always thought the criticism of growth stocks is dumb: the whole point is that you are expecting earnings to grow ... and btw if you want inflation protection you should buy high quality companies with pricing power (that can pass through cost to customers) not crappy companies that are cheap for a reason.
Good points. I don't actually have any hard data on hand to prove this, other than money market funds - total assets increasing by about $1 trillion since Q2 2022 (but bank deposits have decreased by about as much so case to be made that it was deposits funding mmfs, not equities). That's supported by this slide from the Fed: https://twitter.com/EconomPic/status/1721968985179316725
1. I think the aggregate amount of investor capital that has the discretion to rotate from stocks into bonds, and vice versa, based on prices, might be less than we would naturally assume. For example, a large portion (maybe the majority or vast majority now) of 401ks are invested into target date funds, which are explicitly price insensitive. The target date allocation models have no inputs for price. They just keep buying stocks and bonds in whatever ratio the model says to, regardless of price. This, obviously, is a whole issue unto itself which I think likely resovles poorly one day. I am not sure what portion of exisiting or new flows into stocks and bonds come from 401k contributions, but certainly it is material, especially the portion of new flows relative to existing equity.
2. When I wrote that, my thought was that there are certainly a significant number of investors that today are stoked to be getting 4-5% risk-free across the curve and have re-allocated accordingly (myslef included). But if equity outperformance continues as it has in 2023, those same investors are not going to care that they're getting 5% if they think equities are going up 10%. They will performance chase. Bubbles suck everyone in.
Loved this and generally makes sense. One thing:
“Humans are exceptionally adaptable. Investors will adapt to the new rate environment rapidly, if they haven’t already. Many individuals and large pools of capital alike have likely already shifted from stocks into money market funds and bonds yielding 5%.”
Is this empirically true? We entered ZIRP policy in 2009 but it took several years (during which first derivative on rates was zero) for investors to appreciate what that should mean for equity multiples.
As for investors rotating into bonds, most of the charts I see still show equity allocations as percent of overall portfolio near/at all-time highs. (Obviously that’s tough because m2m impacts if, so maybe inflows/outflows are better metric, but haven’t seen/heard about huge equity fund outflows and bond fund inflows.)
The alternative is that investors are too slow to adapt to a new regime. First the market was pricing in rate cuts before “higher for longer” set in. Then the belly / long end of the curve finally moved up. Presumably the next shoe to drop would be equity risk premia increasing.
With that said I’ve always thought the criticism of growth stocks is dumb: the whole point is that you are expecting earnings to grow ... and btw if you want inflation protection you should buy high quality companies with pricing power (that can pass through cost to customers) not crappy companies that are cheap for a reason.
Good points. I don't actually have any hard data on hand to prove this, other than money market funds - total assets increasing by about $1 trillion since Q2 2022 (but bank deposits have decreased by about as much so case to be made that it was deposits funding mmfs, not equities). That's supported by this slide from the Fed: https://twitter.com/EconomPic/status/1721968985179316725
Also, TLT has taken in $18.5 billion through Oct 24, second most of any ETF YTD behind VOO: https://twitter.com/EricBalchunas/status/1716868231313698910
https://twitter.com/EricBalchunas/status/1706649911356166519
Your points bring two things to mind:
1. I think the aggregate amount of investor capital that has the discretion to rotate from stocks into bonds, and vice versa, based on prices, might be less than we would naturally assume. For example, a large portion (maybe the majority or vast majority now) of 401ks are invested into target date funds, which are explicitly price insensitive. The target date allocation models have no inputs for price. They just keep buying stocks and bonds in whatever ratio the model says to, regardless of price. This, obviously, is a whole issue unto itself which I think likely resovles poorly one day. I am not sure what portion of exisiting or new flows into stocks and bonds come from 401k contributions, but certainly it is material, especially the portion of new flows relative to existing equity.
2. When I wrote that, my thought was that there are certainly a significant number of investors that today are stoked to be getting 4-5% risk-free across the curve and have re-allocated accordingly (myslef included). But if equity outperformance continues as it has in 2023, those same investors are not going to care that they're getting 5% if they think equities are going up 10%. They will performance chase. Bubbles suck everyone in.