THE BOTTOM LINE
- For income investors, today’s higher Treasury yields are growing more tempting, when compared to aggregate stock yields.
- But today’s rising rate environment actually makes both asset classes potentially more attractive, albeit for different reasons.
- Over the past five years, the yield of the S&P 500 Index averaged a fairly steady 2.02%, despite some notable ups and downs.
- By comparison, yields for 2- and 10-year U.S. Treasuries hit new 5-year highs, reaching 3.11% and 2.56% on May 16 and 17th, respectively.
- But while bond prices do indeed fall when yields rise, the combined impact of falling prices and higher yields on total return is much more complex. The current environment could mean increased opportunities for higher-coupon income-producing assets. In fact, as coupons rise, the effect of dividends on total return could very well increase.
- For equity investors, the relatively steady aggregate yield of the S&P 500 - during both rising and falling price periods over the past five years - has been supported by the improving financial health of its constituent companies. Both earnings and earnings payout ratios have increased.
- And interest rates are rising at least in part due to an improving overall economic picture – which could likely be positive for stocks.
- It should be remembered that both stocks and bonds are subject to rises and falls in total return over time, but the strengths of each asset class show up there as well; for example, the CBOE 10-year U.S. Treasury Note Volatility Index has averaged 5.22 over the past 5 years, while the more familiar stock-based CBOE VIX Index has averaged 14.67 over the same period.
- Bottom line: Though the pressure on fixed-income yields has its origins in rising rates, investors might be well served to see the longer-term advantages of both asset classes in the current rising rate environment.