R.I.P. The TINA market? Five consideration for the ‘CDs vs. The Market’ debate.

Since 2009, the fed funds rate has averaged 0.6%, spending just 469 days above 2% (9% of the time)1. Similarly, the 10-year Treasury yield has averaged 2.3% over that time, topping 3% for less than 600 days (17% of the time)1. As a result, the term "TINA Market" has been widely used to describe the investment environment over the last decade and a half, with TINA standing for "There Is No Alternative." This is in reference to the conditions created by monetary-policy stimulus, in which ultra-low bond yields offer no compelling alternative to equity-market returns.

With inflation running hot and the Fed embarking on a historic tightening campaign, interest rates haven't been this high since before the iPhone existed, suggesting there is now an alternative (TINAA?). We think the return to higher yields from assets like CDs and short-term Treasuries makes them more compelling than any time over the last decade, but we'd caution against abandoning the longer-term investments in your portfolio due to the allure of what may feel like a good return with relatively low to no risk.

Appropriate cash management and investing in short-term fixed income are core elements of a well-diversified approach. But consider the following five things to help ensure your portfolio remains appropriately geared to the long-term goals it's built to help you achieve, even as CDs have embarked on their comeback tour.

1. Risk is a door that swings both ways

  • We recognize that this year's market declines, coupled with increased short-term yields, have raised the appeal of the perceived safety of short-term CDs and Treasuries. While they are viable investments within a diversified portfolio, we recommend investors avoid the tendency to oversteer in this direction. Such a move could help protect against downside in the markets, but it is not a risk-free approach.
  • We think much of the potential downside in equities and bonds has already been endured.  And we'll likely see further hiccups ahead, but we also think the upside in equities and longer-term fixed income is more promising at this stage.
  • Short-term yields are more competitive now, but over allocating to this area at the expense of equity and bond allocations that are better aligned to your long-term goals can raise the risk that your portfolio falls short of the required returns aligned to those goals.
  • We think there is a credible case that longer-term rates peaked in October. If that proves to be the case, history shows that equity and bond returns over the two years following the peak in 10-year rates will outpace the return that was promised by the prevailing 2-year yield at the time.

Source: Factset, portfolio returns for S&P 500 index and Barclays U.S. Aggregate bond index, 2-year yield of U.S. Treasury bond. Indexes are unmanaged and cannot be invested in directly

This chart highlights the general outperformance of a diversified portfolio following a peak in 10-year yields.

2. When the Fed pivots, so do stocks

  • We don't think the Fed can yet declare victory in the war over inflation, with comments from Fed officials last week aligning to our view that rate hikes will continue, though at a smaller pace, through the early part of next year. Nevertheless, we are growing closer to the end of the Fed's campaign, and history has shown that the period after the last rate hike tends to be quite favorable for equity-market returns.
  • The unique current inflation environment, along with signs of economic resiliency (not enough to fully stave off a downturn, but sufficient to produce only mild recessionary symptoms), will, in our view, prevent the Fed from quickly pivoting to rate cuts.  Instead, we suspect the Fed will seek to pause its policy rate for an extended period to assess economic conditions. The four previous post-rate hiking-cycle pauses by the Fed (2/95-6/95, 5/00-12/00, 6/06-7/07 and 12/18-6/19) saw an average return of 10.4% for stocks and 7.5% for longer-term bonds during those phases1.

Source: Bloomberg, total return for the S&P 500 index. The S&P 500 is unmanaged and cannot be invested in directly.

This chart shows that returns of the S&P 500 are generally positive after the last Federal Reserve hike in a cycle.

3. Inflation-adjusted returns favor equities

  • While CDs and short-term Treasury bonds can provide more predictable yields, investors shouldn't lose sight of both longer-term return potential as well as the impact of inflation on returns.
  • Although current 1- and 2-year yields are more attractive, those real returns will be more significantly impacted by inflation, whereas we believe equities offer a greater potential to outpace inflation over the next several years.
  • We expect inflation to continue to trend lower as we advance. Looking back at prior phases of broadly declining inflation (6/80-6/83, 9/90-12/99, 12/01-12/03 and 9/06-12/10), not only did equities provide positive returns, but bonds also performed well, delivering an average annualized return of 8.3% during those periods1.

Source: Bloomberg, annualized total return for S&P 500 index and Barclays U.S. Aggregate Bond index, 1/1/1980-11/18/2022. Average annual change in the Consumer Price Index (CPI), 2-year U.S. Treasury Bond yield on January 1 each year. Indexes are unmanaged and cannot be invested in directly.

This chart shows that stocks have had higher returns since 1980 than most bonds and returns that beat inflation.

Source: Bloomberg, annualized price change for the S&P 500 index and Barclays U.S. Aggregate Bond index adjusted for annual inflation (inflation measured by y/y change in December CPI). Indexes are unmanaged and cannot be invested in directly.

This chart highlights the outperformance of stocks overtime compared to inflation and 2-year yields.

4. Don't forget about bonds

  • Bond returns have suffered this year, as the Fed has hiked its policy rate while 2-year rates have risen even more sharply. CD rates (approximated by 2-year yields) are now much higher, raising their appeal against the backdrop of falling bond prices.
  • However, during prior rising-rate cycles, when the 2-year yield initially moved more than 1% higher than the Fed's policy rate, longer-term bonds consistently outpaced the 2-year rate of interest over the following 24 months1.

Source: Bloomberg. 2-year rate for U.S. Treasury bonds.

This chart shows that the 2-year yield generally follows the move in the Fed Funds rate.

Source: Bloomberg, annualized returns. 2-year Treasury bond rate. Bond return measured by Barclays U.S. Aggregate Bond Index. Indexes are unmanaged and cannot be invested in directly.

This chart shows the outperformance of longer-term bonds over short-term bonds when 2-year bonds rise more than 1% above the Fed Funds rate.

5. Use a short ladder to step into long-term positions

  • We don't think we've seen the last of market volatility, but we think we're making progress in the bottoming phase of this bear market.
  • We think recession pressures will intensify early in 2023, but, in our view, the lows in the equity market in mid-October already priced in our expected outcome of a mild recession. In other words, we don't think we have to see stocks retreat back to new lows, even as the economy slows. Moderating inflation and less-restrictive policy from the Fed will, in our view, usher in a new bull market over time, supporting our expectation for equities to outperform the current yield provided by CDs over the next few years.
  • We think using a short-term CD ladder (coming due at regular intervals in the near term), as a funding source for a dollar-cost-averaging (DCA) strategy into appropriate equity allocations, is a compelling approach against the backdrop described above.

Source: St. Louis Fed. Past performance is not a guarantee of future returns.

Weekly market stats

Source: Factset. 11/18/2022. Bonds represented by the iShares Core U.S. Aggregate Bond ETF.

Source: Edward Jones