In this “new normal” world of zero to negative interest rates, where long-term Treasury yields are below the yields of many dividend-paying stocks, are bonds becoming an asset class for capital appreciation and dividend-paying stocks the investment of choice for collecting income?
Year to date through July 11, the 10-year Treasury note has a total return of 8.7%, and the 30-year Treasury has a total return of 21.2%, according to the Ryan Treasury indexes published daily in The Wall Street Journal. The S&P 500, in contrast, has returned just 5.35% during the same period.
“I couldn’t care less what yields are as long as they’re going down,” says Gary Shilling, president of A. Shilling & Co., an investment advisory firm, noting that when bond yields fall, bond prices rise.
Shilling says he has “never” bought Treasuries for yield but for appreciation – “the same reason most investors buy stocks.”
As of the close on Monday, July 11, the yield on the 10-year U.S. Treasury note was 1.43%, about 80 points lower than it was a year ago, and the yield on the 30-year Treasury bond was 2.15%, about 100 basis points lower. Both were just slightly above record lows hit last week.
In contrast, the dividend yield on the S&P was 2.17%, well above the yield on the 10-year Treasury and almost equal to the yield on the 30-year Treasury bond. That hasn’t happened since the financial crisis in late 2008 and 2009.
Given the sharp drop in bond yields, many advisors and strategists say yields can’t fall much further from here, but that was the same refrain heard a year ago when they were almost double what they are today.
Shilling, who has correctly forecast falling bond yield for years, now targets a 1% yield for the 10-year Treasury and 2% for the 30-year Treasury by year-end, citing deflationary trends in the global economy coupled with growing demand for U.S. Treasuries from overseas investors searching for yield and safety along with slowing supply growth.
Demand for Treasuries has been strong during the first half of this year. ETF investors, for example, added a net $67.6 billion to fixed income products, a 91% increase in inflows versus the same period a year ago. U.S. investors added $44 billion to fixed income ETF portfolios while European investors added $17.6 billion.
Shilling expects bonds will outperform stocks on a total return basis because of falling yields and slow earnings and revenue growth in an economy where many corporations have little or no pricing power, but he does own defensive high-yielding equity sectors such as consumer staples and utilities.