Since the Great Recession, investors have had one thing on their mind: stocks. The annual rate of return for the S&P 500 over the past 10 years through Sep 30, 2026 was 15.18% measured by Vanguard’s S&P 500 Index fund VFINX. A lot of that time there wasn’t much of an alternative. Today is different. Investors haven’t been paid this much to own long-term Treasuries in more than two decades. While much of the investing world remains focused on AI and stocks, today’s bond yields may offer one of the most compelling risk-reward tradeoffs available.
One way to compare your risk/reward proposition is to compare the Earnings Yield (EY) of the S&P 500 to the Long-Term Treasury rate. The EY of the S&P is just the inverse of the Price to Earnings (PE) ratio. Between 2012 and 2022, except for a brief time during COVID, the S&P 500’s EY range was 4.3% to 6% while long term bond yields were under 3%. When the EY of the S&P is higher than Treasury rates, it makes more sense to take that added risk by investing in stocks.
Today things are different. 20-year Treasury Bonds are paying 5.6%. That 5.6% return is certain if you hold the bond to maturity. We haven’t seen Treasury rates this high since 2002. The EY on the S&P is 3.86%. 5.6% certainty looks really good compared to a 3.86% EY. We also haven’t seen an EY this low outside of the Dot Com crash, The Great Recession and COVID, since 1870 (multpl.com). When I think about where bond yields are relative to EY on stocks historically, I see a real value to adding more fixed income to portfolios. The key to success is to buy low and sell high, right?
Steve Sosnick from Interactive Brokers had a great quote in the Wall Street Journal on Oct 5th regarding rising interest rates and rising stock prices: “Bonds are continuing their trend, and so are stocks… If you think the benefits of AI are essentially infinite, so what if you have to pay more to borrow money?” Do you think AI’s benefits (profitability) are endless? Business cycles happen. What happens if (when) earnings growth or AI investment slows? Higher interest rates should pressure both of those metrics. Investors are probably fine staying heavily invested in stocks if they’re in their 20s or 30s and have a lifetime to recoup potential losses. What if you are in your 50s or 60s or older? Certainty and lower volatility look a lot better for that group.
Obviously every investor’s situation differs, and allocation decisions should reflect individual goals, risk tolerance, and time horizon. That being said, my opinion is that everyone should have some sort of fixed income holding. It lowers the standard deviation of your portfolio. If you regularly rebalance you can take advantage of pricing discrepancies between asset classes. A lot of investors don’t do that though. They drink the Wall Street Kool-Aid and ask the wrong questions such as what is the next hot meme stock, or how can I get into the next trillion-dollar IPO. Prudent investors should ask themselves the question that has been ignored or irrelevant for most of this century: do expected stock market returns adequately compensate for the risk being taken? If the answer is “no” then intermediate to longer term bonds look very attractive by offering a good return and lowering risk on your portfolio. If this post rings a bell, reach out to Zetlmaier Wealth Management to have a fiduciary review your portfolio for hidden risks and to give ideas of how to increase the probability of a good financial future.
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