No risk, high return

Stocks had a mixed close on Friday after stocks rallied from their lows as traders remain uncomfortably uncertain about interest rates. What made “total sense” just a week before had been turned onto its ear by very real Fed speak.

I am just sayin’. I am going to present you with some facts. I am not sure if you heard, but last week, 6-month Treasury Bills auctioned off above 5%... for the first time since 2007! Let’s unpack that. First… 5%! How amazing is it that the US Government is promising to pay you back face value and 5% (annualized) to borrow that money? That is a pretty respectable risk-free return, wouldn’t you say? It seemed like just yesterday when analysts were befuddled as to what number to use for the risk-free rate in all their calculations. They knew that the real number was something like 0%, but that would mess up all their spreadsheets, so, typically they would throw in something like +25 basis points and say something like “whatever, close enough.” These days, selecting which risk-free rate to use is much simpler, but there are other challenges that come with higher rates. Namely, competition for stocks.

Now, I know that no one ever bought a basket of S&P500 stocks for their dividend, but if you did, you could expect a dividend yield of just 1.67%. The Nasdaq Composite has a dividend yield of 0.91%, and the small-cap Russell will yield you 1.48%. Not exactly exciting, eh? Now, granted, those other indexes are expected to provide significant upside in capital gains… over time, which is the primary reason why investors seek opportunity there. The average annual return for the S&P500 is around 9.75% over the past 20 years. That is much better than the 5% yield for boring 6-month T-bills. But is it? Look back at the last 2 sentences and take note of the adjective “average”, please. Need I remind you that the S&P500 returned -19.44% last year? Sure, on average, you can make that up… if you have time. What if you were about to retire this year and your life savings were in the S&P500? Well, as of last December, nearly 20% of it was erased in what was surely a year of anxiety for you.

So, I have a question for you. Now that we have witnessed just how volatile the stock market can be in the wake of not just last year’s losses, but also after the volatility we have witnessed year to date, is a +4.75% premium enough to justify buying stocks over Treasuries? That number is simply the result of subtracting the average return of the S&P500 from the 6-Month T-bill yield (9.75% - 5.00%). Well, is it? The answer is probably not, but it really depends on your time horizon. We know that long-term always pays off in the stock market, but if you don’t have, say 5+ years to be patient, 5% is just about the best news in some 25 years. Taking it a step further, even if you are young and don’t plan to retire for many years, you may want to consider a lower-risk investment for your cash needs within the next few years. Let’s say you are planning to buy a home, buying an engagement ring for your sweetheart of 10-years, paying for college tuition, etc. When Treasuries were yielding 0%, the decision was tough, but today, with all risk-free Treasuries under 2 years yielding at least 4.66% (2-year), you have some legitimate choices.

If you were following this, you may have jumped to the conclusion that something’s gotta’ give? You haven’t? Let me explain. In this scenario, either Treasuries are too cheap… or stocks are too expensive. Further, will Treasuries become cheaper yet in months to come? If so, will stocks suffer the consequences? Most importantly will the risk premium for owning stocks shrink further or will stocks fall to compensate. These are the challenging questions with today’s yields being where they are. If you are looking for lower risk returns within 2 years, your choice shouldn’t be challenging at all.

WHAT’S SHAKIN

Walmart Inc (WMT) shares are lower by -4.29% in the premarket after it provided weak forward guidance for the year. Despite announcing EPS and Revenue beats from Q4 of last year, the company forecasted a decline in earnings of around -6% for the year, when analysts were hoping for a +3.8% gain. Dividend yield: 1.56%. Potential average analyst target upside: +11.0%.

Medtronic PLC (MDT) shares are higher by +2.28% in the premarket after the company announced that it beat EPS and Revenue estimates by +2.78% and +2.72% respectively. The company upped its full year forecast above analysts’ estimates and spoke of solid results despite “softer” procedure volumes and ongoing sourcing challenges from China. Dividend yield: 3.20%. Potential average analyst target upside: +6.5%.

FRIDAY’S MARKETS

Stocks had a mixed close last Friday as investors remained cautious in the wake of last week’s cacophony of hawkish Fed chatter. The S&P500 fell by -0.28%, the Dow Jones Industrial Average gained +0.39%, the Nasdaq Composite Index slid by -0.58%. and the Russell 2000 Index gained +0.21%. Bonds gained and 10-year Treasury Note yields slipped by -4 basis points to 3.81%. Cryptos advanced by +2.11% and Bitcoin slipped by -0.20%.

NEXT UP

• S&P Global Flash Manufacturing PMI (Feb) is expected to have climbed to 47.2 from 46.9.
• S&P Global Flash Services PMI (Feb) is expected to have grown to 47.3 from 46.8. Note that both these PMIs are below 50 which indicates contraction.
• Existing Homes sales (Jan) may have climbed by +2.0% after falling by -1.5% in December.
• The week ahead: still more earnings in addition to FOMC Minutes, GDP, PCE Deflator, more housing numbers, and University of Michigan Sentiment. Please refer to the attached economic and earnings calendars for times and details.
• Earnings after today’s closing bell: Realty Income, Transocean, Coinbase, CoStar, Palo Alto Networks, Toll Brothers, Caesars Entertainment, Diamondback Energy, and Public Storage.