If you’ve been searching for a way to make money amid choppy markets, bonds could be a safer investment than stocks right now.
Investors seek out bonds as a safe haven from the stock market when volatile times roll around. But the rise in bond yields since 2014 has led to lower yields on bonds, meaning that investors are now paying more to own a little less.
On top of that, bond returns have consistently lagged those of stocks in recent years, a historical anomaly that has likely to end sometime soon.
Investors have been wary of stocks since last summer, as concerns grow that the Federal Reserve’s tightening policies could further roil the market.
“Right now, even though we’re seeing a little higher price-to-earnings ratio, I don’t know if that’s enough for investors to feel like they’re in the best of both worlds,” said Scott Minerd, global chief investment officer at Guggenheim Partners.
But fixed income is still a great deal when you look at the long-term trends.
Investors, meanwhile, don’t feel as if they can sit in the sidelines and let a potentially turbulent year pass them by. Even when returns from bonds have slowed, there’s usually a good reason, other than interest rates, that you’re willing to buy.
The widening gap between yields on long-term bonds and stocks could spur the Fed to adopt a slightly more dovish approach to tightening policy, which could ease concerns for bond investors.
There’s a caveat to all of this. If inflation gets out of hand, bond yields could jump and threaten bonds’ recent all-time low yields. Investors may be more concerned about inflation heading higher, not just falling.
Inflation tends to take longer to emerge than short-term investors’ natural inclination to flee stocks for bonds. But the CPI has ticked steadily higher over the past few months. The latest inflation data will be released at the end of the month.
Cary Leahey, managing director at Decision Economics, said he thinks that the Fed is on track to raise interest rates several times this year, despite the uneven 2017. And the Fed will likely hit its 2% inflation target in 2019, Leahey said.
“Our economists … don’t believe you can just look out there and not be concerned about rising interest rates,” Leahey said.
But he added that the biggest mover of bond yields in coming years will be inflation. The key thing to watch is whether the Fed’s job growth trends will allow for faster economic growth that will boost demand for wages. A future uptick in prices could give investors pause about the long-term outlook for rates.
The best buy: Invest in bonds for the simple reason that they are cheaper to hold than stocks. And you have time to wait out any bumps in the market.
The risk of waiting for better returns
When stocks hit historically high valuations a few years ago, investors weren’t willing to hang in there for a prolonged period. The cost of holding bonds such as the iShares 20+ Year Treasury Bond ETF has pared out returns, reducing their attractiveness in the eyes of investors.
In the past three years, the iShares fund has fallen 21.13%, compared to a 5.45% gain for the S&P 500. That’s part of a much longer trend where stocks have outperformed the longer-dated bond fund in recent years.
With yields on the 30-year Treasury at just 2.94%, investors no longer want to bet on the same long-term success that these securities have offered for decades.
“It’s frustrating to see that volatility throughout a period of 30 years where there haven’t been that many times where stocks beat bonds,” said Sean Murphy, a senior vice president of global emerging markets at BlackRock.
But as volatility returns, those who were burned during the past two years will likely pay a higher price for safety.