Evening Brief – 10.24.23

Bonds Over Stocks

On Monday, the 10-year US Treasury yield briefly surpassed 5% (again), retesting its highest level in 16 years, and is currently trading around 4.85%. For buy-and-hold investors, the elevated yield appears enticing to pick up, at least in comparison to recent years in which interest rates were sharply lower.

How does a yield of 5% compare to the performance of the U.S. stock market? Let’s examine how the 10-year yield has performed relative to the S&P 500 Index’s rolling 10-year return.

Higher yields present investors with increasingly competitive alternatives to stocks, which previously benefited from near-zero yields.

Contrast the 4.85% yield with the S&P’s 9.3% annualized return over the preceding 10 years. It is not surprising that stocks outperform 10-year yields, but this is not always the case.

The fact that you can now lock in slightly more than 50% of the 10-year trailing return of the equity market with virtually no risk is alluring. The implication is that it may be an opportune time to increase the proportion of bonds and underweight stocks in a portfolio.

If you had purchased and held 10-year US Treasury notes 10 years ago, you would have earned approximately 2.6%, which is significantly lower than the current 9.3% 10-year trailing return for equities.

Although it is impossible to predict what stocks will earn over the next decade and how this will compare to the expected return of 5% on a 10-year note, the case for owning US Treasuries is significantly stronger today than in years past.

US equities have enjoyed a substantial return premium relative to other asset classes for much of this year’ however, in the current environment, the advance appears increasingly vulnerable.

The competition for stocks is no longer as low as it was when yields were lower, and in some instances virtually zero, before the Federal Reserve began raising the Federal funds rate.