May 18, 2023

Equity outlook – TINA gets dumped for TARA?

Authored by: Chhad Aul, Chief Investment Officer & Head of Multi Asset Solutions, SLGI Asset Management Inc.

So far this year, equities have performed impressively. The S&P 500 is up over 9% and the S&P/TSX Composite has risen 7.5% (year-to-date as of May 1st). This is largely because markets are anticipating a benign scenario of falling inflation, and central banks are expected to pivot to cutting rates in the second half of this year. Beneath the outperformance is the growing risk that equity valuations are back to elevated levels, especially relative to attractive alternatives – like bonds.

Historically, investors expect excess returns to invest in riskier assets like stocks. Called the ‘equity risk premium,’ this depends on the level of risk perceived by market investors. In other words, markets are likely to accept a low-risk premium for equities relative to bonds if they think inflation and interest rates will fall over the next few quarters. In our view, this low-risk premium for stocks might only be justified if rates fall dramatically this year, an outcome we see as doubtful. We believe policymakers are much more likely to keep rates higher for longer until inflation steadily moves towards the 2% target. In our view, a more likely scenario is that earnings expectations will fall more abruptly due to heightened recession risks.

Comparison – S&P 500 earnings yield vs. the U.S. 10-year Treasury yield

The chart below shows the difference between the forward earnings yield for the S&P 500 and the 10-year Treasury yield - one measure of the equity risk premium. By this gauge, investors are accepting the lowest compensation for taking equity risk since 2009, despite earnings risks ahead.

TINA getting dumped for TARA?

Many investors are familiar with the acronyms TINA and TARA. There Is No Alternative to stocks (TINA) refers to the situation where loose monetary policy and low interest rates, like markets enjoyed from 2009 to 2021, made equities the preferred asset classes for investors seeking higher returns. This was in spite of high valuations, where equities were more attractive than the alternative.

There Are Reasonable Alternatives (TARA) is a more recent concept. It has been sparked by rising inflation that has pushed central banks around the world to repeatedly hike interest rates. Although 2022 hit both stocks and bonds, fixed income investors now find themselves with the advantage of attractive yields.

We believe that high-quality bonds now offer attractive income. Also, longer-term fixed income may provide downside protection relative to riskier assets in a recessionary environment. We also see cash as an appropriate allocation as it currently pays a reasonable yield and can be put to work in equities when valuations improve.

As corporate profits deteriorate and economic activity slows, choosing high-quality stocks at reasonable valuations may outperform passive investing. To help with asset allocation decisions in a highly uncertain environment, we offer many solutions that provide access to diverse asset classes with tactically managed allocations.

Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any mutual funds managed by SLGI Asset Management Inc. These views are subject to change at any time and are not to be considered as investment advice nor should they be considered a recommendation to buy or sell. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.

Sun Life Global Investments is a trade name of SLGI Asset Management Inc., Sun Life Assurance Company of Canada, and Sun Life Financial Trust Inc., all of which are members of the Sun Life group of companies. SLGI Asset Management Inc. is the investment manager of the Sun Life family of mutual funds; Sun Life Assurance Company of Canada is the issuer of guaranteed insurance contracts including Annuities, and Segregated Funds. Sun Life Financial Trust Inc. is the issuer of Guaranteed Investment Certificates. 

© SLGI Asset Management Inc., Sun Life Assurance Company of Canada, and their licensors. All rights reserved.