Sujata Rao & Danilo Masoni

LONDON (Reuters – The sudden rise in inflation-adjusted yields this month has jolted TINA. Although the TINA thesis states that there is “no alternative” to stocks, history shows that equities can withstand these increases in real rates and even thrive.

Investors have long considered equities to be the best mainstream asset for generating strong returns, despite 10-year U.S. bond yields that are below minus 1 percent inflation-adjusted.

TINA is suspected to be responsible for the nearly $1 trillion inflow to global equity funds in the last year. According to BofA data this figure surpasses all previous inflows in the past two decades.

However, the Federal Reserve is likely to raise interest rates three-four times this year and with U.S. inflation at around 7%, real yields (the nominal interest rate paid by a bond minus the rate inflation) are in motion.

After a rise in U.S. yields, stocks fell. It was most severe for the tech-heavy, where stocks are based on the assumption that future earnings growth will be strong. This made them vulnerable to higher interest rate.

Nasdaq will have its worst year ever since 2008, with an increase of 40 basis points in inflation-adjusted yields for ten years since Dec. 30, which coincides with the Nasdaq’s second worst start since 2008.

Banks like JPMorgan (NYSE) and Goldman Sachs(NYSE:), advise clients to still buy the dip. They argue that real yields are still very negative at -0.8% and higher interest rates have already been priced in. Company earnings are also in strong shape.

Equities performed exceptionally well in previous periods of increasing real yields provided that economic growth was stable. Bernstein points out that global stocks have returned between 2.3% to 51.8% during the five previous real rate normalization cycles (2005, 1980, 2012-13, 2016, 2020-2021 and 2016).

Bernstein strategists Sarah McCarthy & Mark Diver explained to clients that equities had historically experienced positive returns when real yields normalised towards zero after negative levels.

Data from Truist Advisory Services also shows that the company has enjoyed positive returns for 11 out of the 12 real rate increase cycles, since the 1950s.

JPMorgan predicted that real yields would rise at a slower pace, which will not hurt the markets and economic activity.

JPMorgan said that while the trend is encouraging sector switching, it should not be a deterrent to further sector shifting. Higher real yields can often mean bad news for tech stocks, but they are usually good news in financials and commodities.

For a related graphic on US inflation notes, click https://fingfx.thomsonreuters.com/gfx/mkt/akpezendwvr/US%20inflation%20notes.JPG

JAM TOMORROW

The tech market selloff stems from the assumption that rising interest rates would reduce share prices and lead to a decline in their stock price. The U.S. will experience a steady 100 bps rate rise. Pictet Chief Strategist Luca Paolini stated that TIPS yield results in a 20% decrease in earnings multiples.

Equity valuations have increased globally due to ultra-low rates. But tech stocks which are considered to be “long-duration” assets and therefore negatively correlated to increasing bond yields have ballooned into what many consider to be bubble territory.

It is a gamble on the future earnings potential of tech companies, even though some may not make a profit. Fund managers can see that the current value of an investment decreases as interest rates rise.

According to Refinitiv Datastream, the Nasdaq 100 trades at 27.8x 12 month forward earnings. That’s a 54% premium over MSCI All Country World Index and close to twice that of the 10-year median.

Grace Peters, EMEA head of investment strategy at JPMorgan Private Bank, expects the S&P 500 – also tech heavy and currently trading at 21.1 times forward earnings – to end the year with an average P/E ratio a full percentage point lower.

Expectations that real yields rise must also be accompanied by expectations that equity valuations fall. Multiple compressions could be especially severe for those stocks which are deemed ‘jam tomorrow,’ she stated. This refers to stocks that make a profit on the assumption of future profits.

She added that tangible profits, cash flow and future growth will command higher premia when the Fed raises its rate.

For a related graphic on Nasdaq 100 valuation premium, click https://fingfx.thomsonreuters.com/gfx/mkt/jnpwejlndpw/Nasdaq%20100%20premium.PNG

RETAIL AND TECH

Uncertain is also how retail investors, which are a new player in stock trading but have not been established, will react to rising yields and volatile tech.

The retail market may not find these strategies as rewarding after they have become used to investing in stock market declines under the assumption that monetary stimulus will stop selloffs.

Giuseppe Sersale is Anthilia’s strategist and fund manager. He expects stock markets to lose their momentum gradually – “bounces are going to get more difficult and the declines will be more aggressive.”

He added that “Retail is experiencing fatigue at the moment and it doesn’t have as much firepower as it used to,”