Last year was the worst ever for Treasury bonds, even going back all the way to American independence. This year might be even worse as the Fed keeps tightening and credit rating agencies hover with potential downgrades.
And because yields go up when prices go down, it’s no wonder that long-term bonds now pay significantly more than 4% interest for the first time since the 2008 crash. For investors who have trained themselves to sell stocks when rising yields reduce the value of future profits, the first instinct is fear.
But over the past month, I’ve actually seen more people selectively buying stocks. After all, the argument behind high yields being “toxic” is that they ultimately start competing with stocks for room in investor portfolios. That just isn’t happening here.
For one thing, nobody really wants to lock up their money in long-term bonds paying 4% or even 4.3% when 10-year CDs are paying 5%. The bank products are FDIC insured provided you split your accounts the right way. There’s zero risk that you’ll ever lose money there.
Treasury bonds are also as close to zero risk as it gets. But they pay less. Or if you really want to own government debt, just buy 1-month paper and earn the equivalent of 5.5% a year. But long-term yields keep rising, which means demand is falling.
Demand is falling because the Fed is simultaneously unwinding trillions of dollars worth of bond holdings, turning what was once a huge motivated buyer into a net seller. And meanwhile, the rest of us simply don’t find long-term bonds a good bet right now.
Even Bank of America has given up on its pro-bond posture. They now see 10-year yields climbing to 4.75% by the end of the year. Will that crush stocks? I don’t think so. Money flowing out of bonds is traditionally a sign that stocks are about to rally.
After all, if you want more than 4-5% a year, you aren’t going to get it in bonds . . . especially right now. That Bank of America target implies that bond prices are going to drop another 10-15% in the next few months. That isn’t fun at all, especially for a “risk-free” investment.
Stocks are volatile. They’re unpredictable. When they run aground, they can take years to recover . . . or even never recover at all. But they’re also the only asset class that can do better for investors over time. They can surprise to the upside.
It all depends on the underlying companies. I believe that Corporate America still has what it takes to keep innovating its way around problems. They’ll keep finding efficiencies, recover growth and give shareholders the kind of outcomes that previous generations enjoyed.
Not all executives have what it takes. Some will fall and others will fail. The losers will be left behind in history. But the winners will pick up where they left off. Markets won’t shrink. Winners will take more share and then grow those markets.
Even someone who simply owns an index fund can take advantage of that perennial truth. And those of us who are more selective can flex more than an index fund, underweighting obvious losers, overweighting the most dynamic companies and rotating funds to buy the dip and sell the bubble.
That’s how we reach for more than 4-5% a year. And I think that’s why stocks aren’t collapsing. The good ones are rising to the occasion.