As recently as early last year, a widespread view in investing was that stocks were the only game in town, but now the ground has shifted.
Fixed-income securities are more appealing than they have been in years as the Federal Reserve has raised interest rates to choke off inflation. That underscores that the conventional wisdom on investing is right: It makes sense to hold a healthy allocation of both stocks and bonds.
There is no doubt that stocks are appealing. The stock market may very well have entered a new bull market this year.
The
S&P 500
is up about 23% from the bear-market low it hit in October. The Federal Reserve chose not to raise interest rates last week as policy makers responded to data showing both inflation and demand for goods and services are cooling, so hope is mounting among investors that the economy will stabilize soon. That could boost a host of sectors, while earnings in Big Tech continue to grow briskly because of advancements in artificial intelligence.
Given all that, investors may not be finished loading up on stocks, which promises to help the market over the long term.
Bank of America
private clients, on average, hold about 60% of their total assets in stocks, down from peaks in the mid-to-high 60s dating back to 2014 and the pandemic-era high of 66%, indicating that they could purchase more.
That all makes for exciting possibilities, but the stock market certainly has its risks. The S&P 500 is expensive, trading at about 19 times the aggregate per-share earnings its component companies are expected to bring in over the coming year, so those profits amount to a yield of only a bit more than 5%.
That could trip up the market in the near term if earnings disappoint. Even after the S&P 500 recovers from that potential slide, it may not be much higher in a year than it is today. Evercore strategists recently raised their year-end target for the price to 4450, representing a low single-digit percentage gain from the current level.
Even small market-value stocks have already run higher. While trading at a far lower price/earnings ratio than the S&P 500, the S&P 600 index of small stocks is up 8% from its 2023 low point.
That blend of opportunity and risk in the stock market is why it makes sense to also lock in competitive rates of return with investments in fixed income.
“After 15 years of low rates, investors may be structurally over-allocated to stocks relative to bonds,” wrote Lauren Goodwin, economist and portfolio strategist at New York Life Investments. “Investors may consider a modestly higher structural allocation to bonds.”
Particularly compelling is short-term U.S. debt. The yield on two-year Treasury debt is about 4.7%, enough to potentially beat the stock market in the short term if conditions get rough. It is also comfortably above the declining rate of inflation.
According to the St. Louis Fed, the average annual rate of inflation expected over the next decade is about 2.2%. Someone who buys two-year Treasurys could reinvest the interest payments into longer-dated debt if those rates go up, or buy more short-term debt if the Fed lifts rates again.
The best part of all? Those bullish on stocks could always reinvest their fixed-income interest proceeds into the stock market should it become cheaper.
Write to Jacob Sonenshine at [email protected]
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