For many investors, 2023 may be the first time they consider bonds in their adult lives.
That’s the conclusion of a recently published insight by Goldman Sachs, which predicts bond yields will exceed stock dividends by 2023. This, the paper says, has not happened since the height of the Great Recession in 2008. According to the report:
Bond yields fell after the global financial crisis, making equities seem almost the only choice for investors looking for attractive returns. In fact, equities have significantly outperformed bonds since 2008 and especially since the COVID-19 crisis – the relative The performance of the S&P 500 index versus 30-year U.S. Treasury bonds has reached new peak levels this year, well above those during the tech bubble.”
To be clear, this report refers specifically to revenues rather than revenues. That is, Goldman writes about the interest payments on bonds relative to the dividend payments of a stock portfolio. Return on capital gains is a separate area, in which equities outperform bonds in most economic conditions.
However, it has been an unusual feature of the past 14 years to see stocks reliably outperform bonds. Bond rates often outperform stock dividends because of their reliability. A stock can issue strong dividends at any time, but bonds issue stable, fixed payments. That stability usually leads to higher overall returns for bonds, although that hasn’t been the case for a long time.
So it’s time to dive into bonds? Read on for more insights, and as always, consider matching for free with a vetted financial advisor to determine if greater exposure to bonds makes sense for your particular financial plan.
Why are bonds hot?
A lot of this has to do with jobs.
Despite officially exiting the recession in mid-2009, the US labor market remained weak for another seven years. It wasn’t until 2016 that the unemployment rate reached what economists consider “full” employment, around 4%.
In response, the Federal Reserve held its benchmark interest rate at or near zero from 2008 to 2017. Although the Federal Reserve raised interest rates as high as 2.4% in mid-2019, that process was interrupted by the COVID-19 pandemic, which forced the Federal Reserve’s crash rates back to zero.
The bond market fluctuates widely on the interest rate set by the Federal Reserve. This is partly because many bonds base their own interest rates explicitly on this rate. They define their bond yields as the central bank rate plus some mark-up, meaning that an era of low Federal Reserve interest rates by definition means an era of low market bond rates.
In part, this is because U.S. Treasury bonds (short for all Treasury debt instruments, including bills and bills) set their interest rates based on the Federal Reserve’s rate. Treasury bonds are considered the “safe” asset that the private market must always beat. If a company’s bond offers a lower interest rate than the government, investors will simply buy government bonds for the guaranteed return.
As a result, the Federal Reserve’s persistently low interest rates kept the bond market weak for more than a decade. At the same time, the US stock market went wild. Between 2009 and the end of 2021, the S&P 500 climbed from about 740 points to more than 4,700.
This growth also applied to dividend payments. In most years during this period, the average S&P 500 dividend yield hovered at 2% or higher; a figure that meant significantly higher payouts as those average dividends rose from 2% of 740 points to 2% of 4,700 points. At the same time, the Bloomberg US Aggregate, a standard benchmark for bond yields, posted returns consistently below 1%. Often it recorded average annual losses.
Goldman sees this ground changing.
“[A]After a surge in bond yields this year, new and potentially less risky alternatives are emerging in fixed income: U.S. investment-grade corporate bonds are yielding nearly 6%, have little refinancing risk and are relatively insulated from an economic downturn,” Goldman said in a statement. his report. “Investors can also capture attractive real (inflation-adjusted) returns with 10- and 30-year Treasury Inflation Protected Securities (TIPS) at close to 1.5%.”
This contrasts with a standard, albeit soft by comparison, S&P 500 dividend yield of about 1.7%.
“The yield differential between stocks and bonds has narrowed significantly since the COVID-19 crisis and is now relatively low,” the Goldman report said. “The same goes for riskier credits, which yield relatively little compared to risk-free government bonds. Investors don’t get much compensation for the risk of owning stocks or high-yield credits compared to lower-risk bonds.”
For investors, Goldman sees two strong benefits of bonds in this market.
First, income investors can simply get better profits. Bonds provide fixed, scheduled payments that you can plan around. For many investors looking to take money out of their portfolios, that’s better than the unpredictable nature of dividend payments. Now they can get that predictability without serious opportunity costs.
Second, and perhaps more consistently, Goldman sees this as a safe haven in the event of a coming recession.
“[E]equities,” said Goldman, “and high-yield debt is particularly exposed to an economic slowdown or recession.”
Often the value of stocks during economic volatility is a hedge against inflation. Stock prices and dividends tend to move cyclically with the value of money, so investors can expect combined stock returns to track inflation to some extent. In contrast, fixed income assets often generate low returns relative to high inflation. However, most analysts expect inflation to fall in 2023, limiting this downside protection to an equity portfolio.
Instead, most economists and investors see the greatest risk in 2023 as a general downturn (a recession). In this environment, equities are particularly vulnerable, while the fixed value of bonds often provides a strong hedge.
It’s been more than a decade, but for the first time since T-Pain topped the charts, investors at Goldman Sachs are recommending bonds as the smart play for income investors.
It comes down to
Goldman Sachs expects bond yields to exceed stock dividends for the first time since 2009 next year. This is particularly good news, as a possible recession could make equities a difficult investment.
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