A 5.5% equity earnings yield is low. It has only been lower in 1999-2000 and 2020-2021. What is immediately striking, though, is how little yield premium equities are offering over the official interest rate of 5.25%. Good luck in getting that official rate from a bank savings account. But investors can get this rate, risk-free, directly from the Federal Reserve by buying US money market funds. Not surprisingly, money is flying into these accounts at record rates, though so far overwhelmingly out of bank deposits rather than the stockmarket.
We fear this flight to a safe return of over 5% could soon tempt equity investors to cash in too. Cash has only been such an attractive alternative to equities twice before during this century: in 2000 during the technology, media and telecoms (TMT) bubble, when the equity/cash premium actually went negative; and in 2007, just before the global financial crisis. Neither period ended well for equity investors, and we fear a similar outcome could be lying in wait for markets now.
Even more worrying is what happened after each of these previous crises. The market collapses in both 2000 and 2008 were immediately ‘medicated’ by dramatic interest rate cuts, supporting both equity markets and the real economy.
Today, no such rescue looks likely. With inflation proving more persistent than they promised, central bankers would have to choose between monetary stability (fighting inflation) and financial stability (supporting markets). Without a full-blown recession, there may be no room for rate cuts to bail out financial markets.
Add into this worrying picture a TMT-like boom concentrated in just a few US stocks (year to date, the unweighted S&P 500 is actually down in price terms).
For us, this certainly looks like a situation where discretion may still prove to be the better part of valour. So, whilst taking a cautious view so far this year has been painful, we think the evidence suggests that caution may win out.
