Aja McClanahan
·2 min read
For the last 20 years or so, we’ve seen stock and bond prices move in opposite directions — when stock prices are high, prices in the bond market are typically low, and vice versa. This may cause some investors to choose one or the other — not necessarily based on their level of risk tolerance or personal financial circ*mstances, but rather due to macroeconomic factors that could affect values in either market.
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However, there are periods where the correlation is not as salient. As of this writing, U.S. equities are trading at high and what some might deem grossly overvalued prices while U.S. Treasurys are offering a 4%-plus yield, per MarketWatch.
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Are Bonds as Attractive as They Seem?
Currently, the stock market seems overvalued and poised for extreme volatility and potentially a recession. U.S. bonds look like attractive options for investors who desire more predictability and stability if the market ends up in a freefall.
Joachim Klement, head of strategy at London-based Liberum Capital, still doesn’t think it’s time for investors to ditch their stocks and load up on bonds. He uses “The Fed model,” which compares the stock market’s earnings yield with the real bond yield of government bonds.
The key to his analysis, according to Klement, is to compare real bond yields (not nominal bond yields that don’t account for inflation) to earnings yield (earnings divided by prices), which is a real number that is independent of inflation. Essentially, you’ve got to compare apples to apples, as he explained: “One must compare a real number with a real yield, not a nominal yield that changes as inflation changes.”
This analysis, when charted out for both U.S. and U.K. markets, revealed that although stocks are still relatively overvalued at the moment, they could still outperform bonds in the years to come. Klement concluded in his substack article, “Based on the historic relationship shown in these charts, we would expect stocks to outperform bonds by about 4.5% per year over the coming decade.”
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This article originally appeared on GOBankingRates.com: I’m an Investing Expert — Stocks Will Be Better Than Bonds for the Next Decade
