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Debt-Ceiling Standoff Warps Treasury Trading

Surging demand has driven one-month T-bill prices higher, sending the yield down to 3.313% from 4.675% at the end of March. Bills maturing in three months yield 5.105%—a record incentive for lending to the government for a couple months more, according to Tradeweb data going back to 2001. Meanwhile, the lack of government refunding has led to a shortage of Treasury bills, reducing supply and lifting prices. The Treasury’s checking account at the Fed, known as the Treasury General Account, recently declined below $87 billion, from $964 billion last May. Tax revenues boosted the Treasury’s coffers to $265 billion as of Wednesday, but that remains one of the lowest levels since 2021. In turn, much of their cash has been parked at the Fed’s reverse repurchase facility, which borrows cash overnight from money funds and other institutions in exchange for Treasurys and similarly safe securities. Typically, investors wouldn’t buy bills with lower yields than the 4.8% annualized rate the Fed is now offering overnight. Analysts say some funds might have reached their $160 billion limit in the facility, forcing investors to buy one-month bills instead. Government money-market funds—those that invest in the safest assets such as Treasurys and repurchase agreements—have heavily favored ultrashort-term bonds since the Fed began tightening. According to JPMorgan research, bills with one-month to two-month maturities now make up 44% of those funds’ bill portfolios, up from about a fifth a year ago. Meanwhile, bills maturing in three to six months represent just 2% of their Treasury bill investments, down from roughly a third last May.

Pension Investments in Private Credit Hit Eight-Year High

North American pension-fund investment in private-market loans reached an eight-year high in 2022, even as banks pulled back on lending and default rates inched upward.

The average share of these retirement funds parked in the illiquid, typically unrated debt has crept up steadily to 3.8%, the highest on record, according to analytics company Preqin. Though a fraction of the overall portfolio, private credit now amounts to more than $100 billion in the retirement savings of U.S. and Canadian teachers, police and other public workers, according to a Wall Street Journal estimate based on Federal Reserve data and pension financial reports. And the pensions are planning to add more: Their average target allocation is 5.9%.

The $300 billion California State Teachers’ Retirement System is the latest to show interest in increasing private-credit investment and giving the asset class a permanent place in its portfolio. The Calstrs board Thursday directed staff to include private credit in proposals for the pension’s new asset allocation, which board members will vote on later this year.
The $90 billion Ohio Public Employees Retirement System added a 1% allocation to private credit in January, following in the footsteps of the $450 billion California Public Employees’ Retirement System and the $230 billion New York State Common Retirement Fund, which are building out private-credit portfolios of 5% and 4%, respectively. In Canada, some pension funds took advantage of early-Covid market dislocation to expand their already-robust private-debt portfolios.

The ramp-up is part of a decadeslong pivot by pension funds to private-market assets and other alternatives to stocks and bonds in search of investment returns of 6% or more. U.S. state and local retirement funds are hundreds of billions of dollars short of what they need to cover benefits and market losses in 2022 largely obliterated the funds’ record 2021 gains. Pensions rely on taxpayer funds or worker contributions when investment returns fall short.

When investing in private credit, a pension fund typically gives money to a manager who also collects money from other institutional investors. U.S. pension funds often turn to the same big managers handling their other private-market assets, including Ares Management Corp. , Blackstone Inc. and Oaktree Capital Management LP.
The manager pools the money in a fund that makes loans—typically unrated, subprime loans—to companies or other enterprises for a period of around five to seven years. Often the loans go to private-equity-held firms in areas such as software or healthcare, to pay for an overhaul or restructuring ahead of an eventual sale. But the debt can finance anything from airline leases to credit for online shoppers.

A slowdown in bank lending in 2022 made room for the growth of private-market debt. Investors lent out an estimated $200 billion in private credit last year, up from $156 billion in 2021, according to data from PitchBook LCD, which began tracking those figures last year because the increase was so stark. Meanwhile, institutional leveraged-loan issuance fell by 63% and high-yield bond issuance by 78% from 2021 to 2022, the firm found.
There is more than $1 trillion in total private debt outstanding, according to Preqin. The asset class has taken off over the past decade after rules stemming from the 2007-09 financial crisis made banks more reluctant to issue and hold loans to middle-market companies.
market retreat makes room for pensions to add illiquid, unrated debt.

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Private credit now amounts to more than $100 billion in the retirement savings of U.S. and Canadian teachers and other public workers, according to an estimate.
North American pension-fund investment in private-market loans reached an eight-year high in 2022, even as banks pulled back on lending and default rates inched upward.

The average share of these retirement funds parked in the illiquid, typically unrated debt has crept up steadily to 3.8%, the highest on record, according to analytics company Preqin. Though a fraction of the overall portfolio, private credit now amounts to more than $100 billion in the retirement savings of U.S. and Canadian teachers, police and other public workers, according to a Wall Street Journal estimate based on Federal Reserve data and pension financial reports. And the pensions are planning to add more: Their average target allocation is 5.9%.

The $300 billion California State Teachers’ Retirement System is the latest to show interest in increasing private-credit investment and giving the asset class a permanent place in its portfolio. The Calstrs board Thursday directed staff to include private credit in proposals for the pension’s new asset allocation, which board members will vote on later this year.The $90 billion Ohio Public Employees Retirement System added a 1% allocation to private credit in January, following in the footsteps of the $450 billion California Public Employees’ Retirement System and the $230 billion New York State Common Retirement Fund, which are building out private-credit portfolios of 5% and 4%, respectively. In Canada, some pension funds took advantage of early-Covid market dislocation to expand their already-robust private-debt portfolios.

The ramp-up is part of a decadeslong pivot by pension funds to private-market assets and other alternatives to stocks and bonds in search of investment returns of 6% or more. U.S. state and local retirement funds are hundreds of billions of dollars short of what they need to cover benefits and market losses in 2022 largely obliterated the funds’ record 2021 gains. Pensions rely on taxpayer funds or worker contributions when investment returns fall short.

When investing in private credit, a pension fund typically gives money to a manager who also collects money from other institutional investors. U.S. pension funds often turn to the same big managers handling their other private-market assets, including Ares Management Corp. , Blackstone Inc. and Oaktree Capital Management LP.

The manager pools the money in a fund that makes loans—typically unrated, subprime loans—to companies or other enterprises for a period of around five to seven years. Often the loans go to private-equity-held firms in areas such as software or healthcare, to pay for an overhaul or restructuring ahead of an eventual sale. But the debt can finance anything from airline leases to credit for online shoppers.

A slowdown in bank lending in 2022 made room for the growth of private-market debt. Investors lent out an estimated $200 billion in private credit last year, up from $156 billion in 2021, according to data from PitchBook LCD, which began tracking those figures last year because the increase was so stark. Meanwhile, institutional leveraged-loan issuance fell by 63% and high-yield bond issuance by 78% from 2021 to 2022, the firm found.

“A year ago it was competitive. Now, though, banks aren’t lending and public markets are shut,” said Craig Packer, co-founder of Blue Owl Capital, a private-market asset manager, in remarks to investors last month.


The California Public Employees’ Retirement System is among those building out private-credit portfolios.
There is more than $1 trillion in total private debt outstanding, according to Preqin. The asset class has taken off over the past decade after rules stemming from the 2007-09 financial crisis made banks more reluctant to issue and hold loans to middle-market companies.


Retirement officials said private credit is appealing because interest payments adjust to match prevailing rates and give cash-hungry pension funds a steady income stream. Managers and consultants said the rising rate environment creates opportunity because companies struggling to cover interest costs may be willing to take out relatively expensive private loans to keep cash flowing. And, they said, if a private loan is at risk of default, a small group of lenders can intervene earlier and negotiate more easily than is possible in public markets.

 

 

How Much More Tax-Wise Are ETFs vs. Mutual Funds?

But many don’t know the exact magnitude of those tax savings. It is not insignificant. We decided to quantify just how much post tax performance in a taxable account can be juiced by an ETF as opposed to a mutual fund. On average, our findings show, an ETF gives an extra 0.20 percentage point a year in post tax performance compared with mutual funds, and international-equity ETFs even more upward of 0.33 percentage point on average. To be matched for comparison, the mutual fund and the ETF needed to be from the same fund family, have the same objective and have a similar cost structure. We created roughly 10 matched pairs in each of six different asset classes: U.S. large-cap equity, U.S. small-cap equity, value, growth, international equity and fixed income. Looking at each matched pair in all of the groupings, we then recorded the average annualized post tax returns for the mutual fund and the ETF over the past 10 years. The first interesting finding is that the average U.S. large-cap equity ETF delivered a post tax return of 10.11% a year for the period. The average matched mutual fund delivered a post tax return of 9.95% a year. This implies that an investor can save 0.16 percentage point a year on a posttax basis by going with the large-cap ETF as opposed to the similar mutual fund. The average international-equity ETF delivered a post tax return of 2.75% a year. The average matched mutual fund delivered a post tax return of 2.42% a year over the same period. This yields a postt ax difference in returns of 0.33 percentage point a year—or more than 1 percentage point in excess returns over a three-year period. The results associated with bond and other fixed-income assets offer a slightly different picture. The average fixed-income ETF delivered a post tax return of 0.15% a year over the past 10 years. The average matched mutual fund delivered a post tax return of 0.12% a year over the same period; a difference of just 0.03 percentage point. The greater post tax return that ETFs offer on average, though seemingly small, is important to note and can add up quickly over time—more than a percentage point in extra returns after just five years.

The Best Investment Idea Is Also the Most Obvious

Investing is all about risk and reward, but at the moment it’s mostly about risk and not very much reward. Some risks aren’t just badly rewarded, but are more expensive than holding the very safest forms of money.

The extra yield that can be earned above cash by buying risky junk bonds is the lowest outside the credit bubble of 2007, in data that go back to 1986. A standard, albeit flawed, Wall Street valuation measure shows the smallest extra reward for the risk of holding stocks over cash since the dot-com bubble burst two decades ago.

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So why take the risk and hassle of investing, when a nice safe money-market fund or Treasury bill is so attractive? There are two basic answers. One is that investors don’t expect cash to stay so appealing, and want to lock in future yields. The second is that after a decade when cash was trash with a zero yield, few think of cash as anything other than a temporary place to park money.

That thinking needs to go, at least for now. There’s little reward for venturing out of cash.

The Federal Reserve pays 4.55% to money-market funds on its reverse-repurchase facilities, part of its effort to soak up cash from the economy and keep rates high. That’s more than the yield on safe AA-rated bonds, such as those from Apple or Berkshire Hathaway. These are companies that are rock-solid—but they still carry far more risk than cash held at the Fed or in T-bills, where the three-month yield is 4.54%.

In part this is explained by investors’ expectation of Fed rate cuts starting in the summer, expectations that intensified on Wednesday when Fed Chairman Jerome Powell didn’t push back hard against the recent rally. This has resulted in an inverted yield curve, with yields on longer-dated Treasurys lower than those on short-dated bonds and cash.

But we’ve had inverted yield curves plenty of times before (before every recession in the past 60 years, in fact). Not since the ICE Merrill Lynch index started in 1988 has cash yielded more than safe AA bonds. Investors always demanded a higher premium above Treasurys for the extra risk of the bonds that more than offset the lower yield on longer-dated bonds during the inversion.

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The difference this time is that companies are borrowing for longer, meaning the inverted yield curve lowers their bond yields more than in the past. The extra yield they pay above Treasurys, though higher than at many points in the past, is still low and not enough to bring yields back above cash.

Stocks are harder to analyze because they don’t promise a fixed coupon, unlike bonds. The standard way to extract the future premium they offer is to compare cash or bonds to the earnings yield on stocks, profit divided by price, or the inverse of the PE ratio.

The earnings yield is currently 1 percentage point above the rate on a three-month T-bill, an extraordinarily low level considering the riskiness of stocks. Again, some of that is because investors are betting that the Fed will move into rate-cutting mode later this year, helping stocks.

Some of it is because the measure is flawed, comparing the nominal return on cash with earnings, which have some connection to inflation.

But much of it is because stocks are still expensive compared with interest rates, even after the big selloff last year.

One way to try to fix the problems is to compare the earnings yield on stocks with the 10-year real yield, from Treasury inflation-protected securities (TIPS.) Here stocks offer a pickup of 4.5 percentage points over TIPS, which doesn’t sound too bad. But it is: This is the lowest extra reward since 2007.

Some might believe that the risks of stocks and bonds are lower than in the past, that a soft landing for the economy is a sure thing, or simply be happy to take risk even for lower rewards than usual.

Indeed, just because risky assets are expensive compared with cash doesn’t mean cash is sure to outperform. If everything goes as markets expect, interest rates will fall, stocks rise and those who locked in their yield on longer-maturity corporate bonds will be happy.

But think about reward for risk taken. Risk-free cash—debt-ceiling-driven default aside—looks very attractive.

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Our information/charts  are NOT buy/sell recommendations. Are  strictly provided for educational purposes only. Trade at your own risk and analysis.

 

 

 

 

Net profit margins for S&P 500 companies are poised to drop for the sixth quarter in a row

This year’s stock rally has a surprising feature: a smaller share of revenue at big U.S. companies is reaching the bottom line.

With fourth-quarter earnings season nearly complete, the net profit margin of companies in the S&P 500 has fallen to 11.3%, based on actual results and analyst estimates for companies that have yet to report. That would mark the sixth consecutive quarterly decline from the peak of 13% in 2021, according to FactSet.

Rising costs for key inputs such as labor, materials and energy are denting corporate profits across industries, even as sales are rising. Relief for companies isn’t necessarily on the way. Home Depot Inc., HD -7.06% for instance, warned Tuesday that its profits will fall this year as the home-improvement chain invests an additional $1 billion into wage increases for its hourly employees. Walmart Inc. WMT 0.61% offered a muted outlook as well and said inflation continues to keep prices high. The stocks fell 7.1% and rose 0.6%, respectively.

Falling profits worry investors because they can portend an economic slowdown and leave companies strapped for cash. That could lead to less spending on new corporate projects, or crimp investor payouts such as dividends or stock buybacks. 

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Stocks have gained an average of 5.3% after a year of falling S&P margins, according to Dow Jones Market Data going back to 2002. The average annual return in that period was 6.6%. Stocks rose in five of the seven years, but suffered steep declines in the other two.

The margin pinch is another headache for investors, who are still facing the impact of sharply higher interest rates, an uncertain economic outlook and stubbornly high inflation. The S&P 500 has climbed 4.1% this year but is down 17% from its high in early 2022.

Profit margins swelled well above historical norms during the pandemic, helping the U.S. avoid what many economists worried would be a prolonged slump. Unprecedented stimulus meant consumers spent big on goods when Covid-19 restrictions dominated daily life.

When those restrictions ended, spending surged on services such as concerts and dining out surged. Inflation picked up and interest rates rose sharply, but companies had little trouble passing higher costs on to consumers, at least initially.

Now, the economic picture is far murkier. The inflation rate is declining, but consumer prices still grew 6.4% in January from a year earlier. Retail sales were stronger than expected last month but disappointed in the fall. The U.S. unemployment rate sits at the lowest level since 1969, yet many of the largest employers in tech and other industries are cutting staff.

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Where Are Stocks, Bonds Headed Next?

     After languishing throughout last year, growth stocks have zoomed higher. The outlook for bonds is brightening after a historic rout.

The rebound has been driven by renewed optimism about the global economic outlook. Investors have embraced signs that inflation has peaked in the U.S. and abroad. Many are hoping that next week the Federal Reserve will slow its pace of interest-rate increases yet again. China’s lifting of Covid-19 restrictions pleasantly surprised many traders who have welcomed the move as a sign that more growth is ahead. 

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Still, risks loom large. Many investors aren’t convinced that the rebound is sustainable. Some are worried about stretched stock valuations, or whether corporate earnings will face more pain down the road. Others are fretting that markets aren’t fully pricing in the possibility of a recession, or what might happen if the Fed continues to fight inflation longer than currently anticipated.

Once a relatively placid area of markets following the 2008 financial crisis, currencies have found renewed focus from Wall Street and Main Street. Last year the dollar’s unrelenting rise dented multinational companies’ profits, exacerbated inflation for countries that import American goods and repeatedly surprised some traders who believed the greenback couldn’t keep rallying so fast. 

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The factors that spurred the dollar’s rise are now contributing to its fall. Ebbing inflation and expectations of slower interest-rate increases from the Fed have sent the dollar down 1.7% this year.

Even after the S&P 500 fell 15% from its record high reached in January 2022, U.S. stocks still look expensive.

Of course, the market doesn’t appear as frothy as it did for much of 2020 and 2021, but a steeper correction in prices ahead.

The broad stock-market gauge recently traded at 17.9 times its projected earnings over the next 12 months, according to FactSet. That is below the high of around 24 hit in late 2020, but above the historical average over the past 20 years of 15.7, FactSet data show.

Investors repeatedly mispriced how fast the Fed would move in 2022, wrongly expecting the central bank to ease up on its rate increases. They were caught off guard by Fed Chair Jerome Powell ‘s aggressive messages on interest rates. It stoked steep selloffs in the stock market, leading to the most turbulent year since the 2008 financial crisis.

Current stock valuations don’t reflect the big shift coming in central-bank policy, which will have to be more aggressive than many expect. Though broader measures of inflation have been falling, some slices, such as services inflation, have proved stickier. Positioning for such areas as healthcare, would be more insulated from a recession than the rest of the market, to outperform.

Gone are the days when tumbling bond yields left investors with few alternatives to stocks. After a turbulent year for the fixed-income market in 2022, bonds have kicked off the new year on a more promising note. The Bloomberg U.S. Aggregate Bond Index—composed largely of U.S. Treasurys, highly rated corporate bonds and mortgage-backed securities—climbed 3% so far this year on a total return basis. That is the index’s best start to a year since at least 1989, according to Dow Jones Market Data. 

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It is important to reconsider how much of an advantage stocks now hold over bonds, given what he believes are looming risks for the stock market. He predicts that inflation will be harder to wrangle than investors currently anticipate and that the Fed will hold its peak interest rate steady for longer than is currently expected. Even more worrying, it will be harder for companies to continue passing on price increases to consumers, which means earnings could see bigger hits in the future.

Among the products, in the fixed-income space are higher-quality and shorter-term bonds. Still, he added, it is important for investors to find portfolio diversity outside bonds this year. For that, commodities as attractive, specifically metals such as copper, which could continue to benefit from China’s reopening.

Fidelity Investments, said she can still identify bargains in a pricey market by looking in less-sanguine places. Find the fear, and find the value.

The S&P 500 is trading above fair value, she said, which means “there just isn’t widespread opportunity,” and investors might be underestimating some of the risks that lie in waiting. 

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Net profit margins for S&P 500 companies are poised to drop for the sixth quarter in a row

This year’s stock rally has a surprising feature: a smaller share of revenue at big U.S. companies is reaching the bottom line.

With fourth-quarter earnings season nearly complete, the net profit margin of companies in the S&P 500 has fallen to 11.3%, based on actual results and analyst estimates for companies that have yet to report. That would mark the sixth consecutive quarterly decline from the peak of 13% in 2021, according to FactSet.

Rising costs for key inputs such as labor, materials and energy are denting corporate profits across industries, even as sales are rising. Relief for companies isn’t necessarily on the way. Home Depot Inc., HD -7.06% for instance, warned Tuesday that its profits will fall this year as the home-improvement chain invests an additional $1 billion into wage increases for its hourly employees. Walmart Inc. WMT 0.61% offered a muted outlook as well and said inflation continues to keep prices high. The stocks fell 7.1% and rose 0.6%, respectively.

Falling profits worry investors because they can portend an economic slowdown and leave companies strapped for cash. That could lead to less spending on new corporate projects, or crimp investor payouts such as dividends or stock buybacks. 

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Stocks have gained an average of 5.3% after a year of falling S&P margins, according to Dow Jones Market Data going back to 2002. The average annual return in that period was 6.6%. Stocks rose in five of the seven years, but suffered steep declines in the other two.

The margin pinch is another headache for investors, who are still facing the impact of sharply higher interest rates, an uncertain economic outlook and stubbornly high inflation. The S&P 500 has climbed 4.1% this year but is down 17% from its high in early 2022.

Profit margins swelled well above historical norms during the pandemic, helping the U.S. avoid what many economists worried would be a prolonged slump. Unprecedented stimulus meant consumers spent big on goods when Covid-19 restrictions dominated daily life.

When those restrictions ended, spending surged on services such as concerts and dining out surged. Inflation picked up and interest rates rose sharply, but companies had little trouble passing higher costs on to consumers, at least initially.

Now, the economic picture is far murkier. The inflation rate is declining, but consumer prices still grew 6.4% in January from a year earlier. Retail sales were stronger than expected last month but disappointed in the fall. The U.S. unemployment rate sits at the lowest level since 1969, yet many of the largest employers in tech and other industries are cutting staff.

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SPAC Slowdown Tests Asia’s Fledgling Market for Blank-Check Firms

Two of Asia’s financial hubs aimed to reinvent the SPAC. So far, it is proving slow going. Exchanges in Hong Kong and Singapore have always said they aim for quality not quantity with their rules for blank-check companies, touting better investor protection than in the U.S.

But as the U.S. SPAC business has lost momentum, global banks and international investors have grown more cautious about their involvement in these vehicles. And market turmoil brought on by the Ukraine war and the Federal Reserve’s interest-rate increases has made it harder to sell new listings to investors.

SPACs, or special-purpose acquisition companies, are cash shells that first raise money from public investors and list on an exchange, and then hunt for private companies to merge with. 

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Nine months after SPACs were allowed in Singapore, just three such listings have taken place. In Hong Kong, where rules took effect in January, only two have gone public. The second, Vision Deal HK Acquisition Corp. , listed earlier this month.

That is a far cry from the U.S., where even as investor appetite has cooled, nearly 70 SPACs have listed this year, according to data from industry tracker SPACInsider.

Most of those 12 applicants, all of which are backed by mainland Chinese or Hong Kong investors, rushed to file in the first three months of 2022 and the majority are still awaiting approval. No new applications have been lodged in Hong Kong in the past two and a half months.

Pent-up demand from Chinese investors has, in part, helped fill Vision Deal’s order book. Vision Deal raised the equivalent of $127 million after allocating the vast majority of shares to mainland Chinese and Hong Kong investors.

Both Singapore and Hong Kong drew lessons from the U.S.’s experience and adopted strict requirements that hold SPAC sponsors and investment banks accountable for the eventual merger transaction, known as a de-SPAC.

Hong Kong mandates that at least 20 institutional investors buy into each SPAC IPO and has detailed rules about independent investors funding de-SPAC transactions.

Both requirements could amount to serious hurdles. The Asia Securities Industry & Financial Markets Association, a trade group, last year urged against the requirement for SPAC IPO investors, saying even in the U.S. there were only about 40 active institutional investors in SPACs.

Another challenge could be finding independent investors to put in fresh capital alongside the merger. “Unless the target is extremely attractive, it would be challenging for most SPAC promoters to find sufficient investor demand for the deal,” said John Baptist Chan, a Hong Kong-based partner at law firm King & Wood Mallesons, which advised the trade group on its feedback to the SPAC consultation.

In Singapore, no new SPAC applications have been filed since the trio of IPOs at the end of January, all linked to state investment behemoth Temasek Holdings.  

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It’s Time to Buy Bonds?

The market narrative is obvious after a twin inflation and interest-rate shock crushed asset prices: nothing else much matters.

The parallels from history are equally obvious. In 1973, the Arab oil embargo trashed the economy and led to sharp interest-rate rises, while in 1980 rampant inflation worsened by another oil shock was accompanied by then-Federal Reserve Chairman Paul Volcker’s aggressive rate increases. Russia’s invasion of Ukraine was followed by the Fed’s fastest rate rises since Mr. Volcker was in charge.

Yet sometimes the differences to history are as important as the similarities. Economic comparisons matter, of course, but the starting point of valuations often matters even more.
In both 1973 and 1980, stocks took a long time to recover, especially after adjusting for inflation. From a January 1973 high, it took until 1985 for investors to get their money back from U.S. stocks in real terms, as measured by the MSCI USA index with dividends reinvested. In 1980, inflation was beaten and recovery was quicker, but it still took until 1983 before investors who bought at that year’s peak were made whole.
So far, so simple.  If stocks merely rack up an average performance, it will take three to four years for investors to get back to where they started last year, after inflation. That would be a decent performance by historical standards.

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In both the 1973 and 1980 falls—and in every recession and major downturn since—bonds far outperformed stocks. This time, stocks and bonds have fallen together, with the MSCI USA down 16.7% from its high in January last year, and benchmark 10-year Treasurys down 16% since then, both with income reinvested.

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In the past, it took a very long time for stocks to catch up with bonds. That’s because stocks were so overvalued. A bond investor was ahead for 13 years after 1973, and seven years from 1980, when using the Bloomberg Treasury index. It might come as a surprise to those who saw the value of their Treasurys trashed by inflation last year, but from the 1973 and 1980 stock-market highs, bonds proved more resilient than stocks in both inflation shocks, albeit still falling far behind inflation.
This time it wasn’t just stocks that were overvalued. The unusual thing about this bear market is that it started with bonds wildly overvalued too. As a result, so was pretty much everything else. The “everything bubble” burst as central banks abandoned low-for-long rates and turned from buyers of bonds to sellers, leaving investors nowhere to hide.

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Financial psychologists warn that investors ought to dismiss past losses and focus purely on the future. It doesn’t matter how long it takes to make back the previous high. It matters whether stocks will go up from here, and whether they will make more than other assets, the biggest alternative being bonds. Again, the economic fundamentals matter. Will there be inflation and/or recession?
But the starting point matters at least as much. Even after their big falls, stocks still look very expensive compared to bonds. The optimism that started this year has faded, but investors continue to bet that long-run inflation will come back under control and profit margins will stay high. And many remain wary of bonds, even as yields approach 4% on the 10-year Treasury and are above 5% on six-month bills.

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The central lesson of financial history is that, over the long run, U.S. stocks beat bonds. But buying stocks when they are expensive—at 18 times estimated earnings for the next 12 months, they have rarely been pricier outside the dot-com bubble and the postpandemic boom—is a recipe for substandard returns. At the same time, Treasury yields are back up to decent levels. There’s plenty of scope for bonds to disappoint if inflation turns out to be endemic. But at least they start out at a reasonable valuation, based on current yields.
Investors who rightly abandoned bonds when yields were stupidly low should add them back as ballast to their portfolio. This not only smooths returns, but offers a decent income along the way. Bonds also, importantly, provide some protection against the risk that stocks aren’t merely highly valued, but still overpriced.

Gold Prices Buoyed by Rally as Investors Get on Board

Gold purchases by everyone from central banks to institutions and ordinary investors have lifted the precious metal in 12 of the past 17 sessions, according to Dow Jones Market Data.

The most-actively traded gold futures contract has climbed nearly 20% from its September low to about $1,930 an ounce—its highest level since April 2022. Prices are poised to gain for the sixth consecutive week, which would mark the longest weekly winning streak since the nine-week run that carried gold to a record of $2,069.40 in August 2020.

The advance comes after rising interest rates dragged gold to a lukewarm 2022. Gold avoided the steeper, double-digit losses suffered by stocks and bonds, but still disappointed those who had expected it to thrive during a time of elevated inflation. Now, signs of cooling price increases and weakening growth are lifting investors’ hopes of a respite from the Federal Reserve’s aggressive rate increases. 

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The yield on the 10-year U.S. Treasury inflation-protected security, a gauge of the risk-free return investors can get from bonds after adjusting for expected inflation, shot upward last year from a trough of around minus 1% in March to as high as positive 1.75% in October. Rising real yields tend to drag on the price of gold by diverting cash into alternative safe investments. That pressure, however, has abated in recent months, with the 10-year TIPS yield recently back down to 1.2%

Hedge funds and other speculative investors have pushed net bullish bets on gold to the highest levels since April 2022, according to Commodity Futures Trading Commission data tracking futures and options during the week ended Jan. 17. That is a sharp divergence from their bearish positioning during fall of last year.

Other precious metals are also enjoying a resurgence. Silver and platinum, both of which are used as precious and industrial metals, have added 23% and about 6.5% over the past three months, respectively.

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