US stocks and bonds have largely been selling off this year, with bond yields across the curve stepping higher. Richer rates offered to investors to buy government bonds may look somewhat alluring but stocks, for now, are the better bet, two market experts told Insider. Inflation is running around 8%, denting returns for bondholders. Loading Something is loading.
Bond yields continued to rise after the Federal Reserve hiked interest rates, but there is still a long way to go before bonds offer a more attractive return for investors than stocks, two market experts say.
Investors in the volatile first quarter of 2022 have been whipsawed by an increasingly hawkish Fed as consumer price inflation climbed to a 40-year high and a surge in commodity prices after Russia invaded Ukraine last month.
The mix of events has fed into selloffs in both the US bond and stock markets. The S&P 500 was down more than 5% after being thrown into a correction, while government debt was veering toward its worst yearly performance since 1949, Bank of America said Friday. Treasury yields, which move inversely to bond prices, have sharply marched up. The yield on the 2-year note and the 10-year bond have each climbed to levels last seen 2019, well above 2%.
The richer rates offered to investors to buy government debt may look somewhat alluring to investors looking to boost their returns, but it’s far from clear that rising bond yields have dented the appeal of equities. “I think still at this point, stocks offer the better opportunity,” Liz Young, head of investment strategy at personal finance platform SoFi, told Insider.
Hot inflation plays a big role in making such an evaluation as inflation eats into the value of coupon interest payments owed to bondholders. Pandemic-era jumps in prices for food have contributed to driving the consumer price index to 7.9% in February. Surging crude prices as major energy producer Russia launched war against Ukraine kicked up average national gas prices above $4 a gallon.
“Really what you’re looking for is the trade-off between risk and reward and nobody knows what the actual top is on bonds or what we would call the ceiling,” Young said.
Yields could move even higher in anticipation of the Fed hiking interest rates six more times in 2022 to combat high inflation. Policymakers this month started raising the benchmark lending-rate range by 0.25%.
Generally, bonds become more attractive than stocks when the yield on the 10-year Treasury moves above the average dividend yield on the S&P 500, Young said. The 10-year Treasury yield was 2.4% on Friday and the S&P 500 dividend yield, gauged quarterly, fell to 1.27% in December 2021.
“However, because of inflation, when you adjust the yield on the 10-year, you come up with a real yield that’s negative,” she said. With inflation around 8% and the 10-year yield at 2.4%, the real yield sits at around negative 5.6%.
“Thinking of it from that perspective, bonds are still not attractive, and if they’re not offering the price upside potential to make up for that inflation, they remain unattractive,” said Young. “Whereas stocks – even though you look at the dividend yield and you subtract inflation, same situation where the real dividend yield is negative – you have upside potential in stocks still.”
Jim Paulsen, chief investment strategist at Leuthold Group, said he would favor stocks “much more than bonds,” for now.
“Historically, what I’ve found is that until the 10-year Treasury gets above 3%, stocks have really done almost twice as well as they do otherwise in terms of returns on average. There’s something kind of magical about that 3% level,” he told Insider.
“While I might own some [bonds], I don’t think I’d be putting more [money] in until maybe yields get back up above 3%. Maybe I’d revisit it at that point.”
According to data from CFRA, the last time fixed income offered more attractive returns than stocks was in 2020, with the iShares 20+ Year Treasury Bond ETF, or TLT, just edging out the SPDR S&P 500 ETF Trust, or SPY, the world’s biggest exchange-traded fund. TLT in 2020 posted an annual return of 16.4% versus 16.2% for SPY.
Investors in the week ending March 23 pulled a net $208 million out of bond funds, fund tracker EPFR said Friday. Bond funds logged their 11th consecutive outflow. However, the latest total was the smallest since the run began in early January, it said.
A CFRA table shows yearly returns for the TLT and SPY ETFs CFRA, S&P Global