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 Anxiety over the two-day Fed policy meeting, centered on
expectations the central bank will likely drop its pledge to keep
interest rates low for a "considerable time," was a primary driver
behind stocks snapping a five-week winning streak this week and
bonds absorbing their steepest losses in at least two months.
Top economists at several firms say they see at least even odds the
Fed will nix the phrase from its forward guidance, which some
traders may interpret as meaning that rate hikes could come as early
as next March.
"If investors feel the Fed is becoming more hawkish, that's actually
a negative for all asset classes with the exception of the dollar,"
said Chris Gaffney, senior market strategist at EverBank Wealth
Management in St. Louis, Missouri.
Still, few expect such a move would translate immediately into a
long-term change in investors' bullish view of stocks, especially
relative to bonds.
To be sure, signs of sooner-than-expected interest rate hikes could
chip away at investors' optimistic view of stocks, which scaled to
new heights in no small part thanks to the Fed’s quantitative easing
program and decision to hold interest rates near zero percent for
nearly six years now.
But with bond yields still extraordinarily low by historic
standards, and unlikely to rise drastically, many investors see
equities as one of their few prospects for long-term growth.
Market watchers say it is unlikely the prospect of interest rate
hikes will significantly dampen investors’ taste for stocks or
prompt a large-scale reallocation of funds into bonds.
“There's no doubt that there will be some volatility in the short
term, but at some point equilibrium will come into the market,” said
Quincy Krosby, market strategist at Prudential Financial in Newark,
New Jersey.
While measures such as the forward price-to-earnings ratio on the
S&P 500 <.SPX> suggest stocks are their priciest in nearly a decade,
other measures of relative valuation to bonds remain skewed in favor
of equities.
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The S&P's so-called earnings yield, the inverse of the
price/earnings ratio and a common yard stick for comparing equity
valuations against bonds, is roughly 6.3 percent. That is 3.7
percentage points higher than the 10-year Treasury yield, currently
2.6 percent, whereas the long-term spread between the two is about
1.5 percentage points.
When measured against corporate junk bonds, the bond market's
biggest competitor to stocks for asset flow, valuation math is
tilted even more heavily in favor of equities. The average yield to
maturity on junk bonds is just 6.3 percent, according to Bank of
America/Merrill Lynch fixed income index data, but the long-term
average junk yield is 9.4 percent.
Moreover, U.S. corporate earnings are projected to resume
double-digit growth in coming quarters, according to Thomson Reuters
data, which would keep a lid on P/E multiple expansion, perhaps even
compress it if profit growth outpaces stock price increases.
That suggests stocks remain the better bet for returns, at least
until interest rates rise significantly enough to return relative
valuation measures between the two to historic norms.
In the current market environment, "There’s not really a better
alternative to stocks right now," says Gaffney.
(Reporting by Akane Otani; Editing by Leslie Adler)
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