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Written by: Jacob Johnston | Advisor Asset Management
After one of the most aggressive rate hike cycles on record, the average yield on money market funds has topped 5% for the first time since 2007.
Source: Crane Data, Barron’s | Past performance is not indicative of future results.
These higher rates have increased the competition for capital from cash and cash-like instruments such as money market funds. This is making an impact in at least two noticeable ways: fund flows and equity market performance.
Flows
So far this year, money market funds have seen a massive $769 billion of inflows, compared to $172 billion into equity ETFs (exchange-traded funds) and $125 billion into Fixed Income ETFs. In August alone, money market funds drew $67 billion while equity ETFs saw inflows of $7.5 billion. That’s a 9x ratio of inflows into money market funds verse equity ETFs.
Source: Strategas | Past performance is not indicative of future results.
We suspect the flows into money market funds have, in part, been at the expense of dividend-paying equities. After record inflows of over $74 billion into dividend-focused ETFs in 2022, flows have come to a halt attracting only $3.9 billion so far in 2023.
Source: Strategas | Past performance is not indicative of future results.
Performance
The S&P 500 gained 18.72% year to date through August, however, performance has been very split. The “average stock” as measured by the S&P Equal Weight Index gained just 7.22%, while the Russell 1000 Growth Index gained 32.16%, and the Russell 1000 Value Index gained 5.86%.
One factor that has been key in relative performance has been the dividend profile of the stock. According to Ned Davis Research, non-dividend-paying stocks have gained 14.9% on average through August, while dividend-paying stocks have gained just 3%. A look at S&P 500 returns grouped by dividend yield shows dividend-paying stocks with a yield greater than 2% are essentially flat — they simply have not participated in the equity market advance in 2023.
Source: FactSet | Past performance is not indicative of future results.
Money market funds with 5% yields clearly provide a reasonable alternative to equities. This can be measured by the Equity Risk Premium that compares the earnings yield of the stock market to the yield on the 10-year U.S. Treasury. It suggests an excess return that investing in the stock market provides over a risk-free rate. Our work suggests the Equity Risk Premium is still slightly positive, however, it is at the lowest level since 2004.
We suspect that at some point money market rates will normalize and investors will turn their attention toward longer-term objectives, directing money back into the equity markets and potentially the dividend space. The benign performance this year has created relatively attractive fundamentals i.e., the Dow Jones Select Dividend Index has a current price-to-earnings (P/E) ratio of 11.5 and a dividend yield of 4.6%, compared to the S&P 500 Index P/E ratio of 20.5 and a dividend yield of 1.6%. The combination of lower valuations and higher dividend income could offer a margin of safety for investors looking to put money back to work in the equity market.
Related: As Rate Hikes Near End, Historic Investor Opportunity May Begin