Most strategic investors may consider that stocks are always better than bonds. After all, gains in NVIDIA, Meta, Apple, and others have been hard to compete with over time. “Always” is a very long time. There are times when strategic investors need to be focused on long-term bonds. This is not a call to rotate out of all stocks to move all assets into bonds. It just doesn’t require very long of a memory to know that the stock market can fall and fall handily. And when stocks do fall, it has historically been a great time to own long-term bonds.
The yield on the 10-Year U.S. Treasury Note rose from under 1.5% in 2021 to about 5% in late 2023. In that same period, the rate on the 30-year Treasury rose from under 2% to about 5% as well. Now the 10-year yield is close to 4.3% and the 30-year yield is about 4.4%. This could be nearing the last time that long-term bond investors can lock down high interest rates if some key market forecasters are proven to be correct.
There is never an assurance that one asset class is better than another asset class. After all, the future hasn’t happened yet. In mid-2024, there are some signs that long-term bonds may be sitting pretty for investors with very long-term outlooks.
And don’t ever forget that most investors didn’t get rich buying bonds — they stayed rich by buying bonds!
GOLDMAN SACHS SAYS…
Goldman Sachs recently made news for strategic investors after raising its 2024 year-end target for the S&P 500 Index. The firm’s target was raised from 5,200 to 5,600, based on mega-caps, a milder-than-average negative earnings revisions, and of course higher valuation multiples all boosting the index. Just keep in mind that is versus over 5,400 today!
What may stand out even more is that Goldman Sachs may have just given strategic investors an even stronger reason to buy long-term bonds over stocks. Strategic investors should take note that the S&P 500’s gain was about 15%. While earnings contributed, the multiples that investors paid up for key mega-caps was an even stronger contributor.
Goldman Sachs has stood by its prediction of two Federal Reserve rate cuts in 2024. The first is expected in September, ahead of the November election. The second Fed rate cut is expected likely in December. If this holds true then it might be a true gift from Santa.
WHAT ABOUT REAL TREASURY YIELDS?
The yield of the 1-year Treasury bill at about 5.10% (and a 6-month Bill at 5.35%) sounds better on the surface than the 10-year’s 4.27% yield and the 30-year’s 4.40%. That’s a problem with the inverted yield curve. For long-term investors, keep in mind that the 5.10% yield is only for a year while the 4.3% to 4.4% is for the next 10 years to 30 years.
If the economic cycles play out and we face slower growth over the coming decade — and with the hope of lower inflation — then locking in 4.3% to 4.4% now rather than playing for 5.1% for just a year should actually prove more attractive. “Should” still means there are no guarantees.
AND LOW/NO INTEREST RATES (EVER AGAIN)?
Investors may need to forget about the age of negative interest rates and zero interest rate policies for the time being. But are NIRP and ZIRP really dead? If the U.S. Treasury is locked into $1 trillion in debt servicing costs every year indefinitely at current rates, then the only way to lower that annual interest rate servicing cost is to lower interest rates.
U.S. DROWING IN DEBT
The U.S. debt has now hit $34.7 trillion and it’s just going to keep growing unless draconian austerity measures are taken. And draconian austerity measures will be more painful than the public (and any politician) can endure. So, again, that means that the only way to cushion the annual debt servicing costs is to lower rates.
A REAL CONFLICT OF INTEREST
There is almost a conflict of interest for the government in keeping rates higher for longer. Keeping higher rates (or at-market rates today) forces higher interest costs every year into the future. That also means under the current budgets that items like Social Security, Medicare, education, defense, infrastructure may all suffer just for the government to pay its annual interest payments on the debt it has accumulated.
Default is simply not an option. A real U.S. default on its debt would be unfathomable to the global financial markets. Forget a meager debt rating downgrade by the ratings agencies. If the U.S. were to default on its interest payments then no entities in the world would be deemed safe. So, barring outright war or other nasty scenarios, the only long-term solution on top of a real balancing of the budget is to have interest rates lower.
GOVERNMENT INCOME VS. SPENDING
In fiscal year 2023, the federal government spent $6.13 trillion versus income of about $4.44 trillion. At the same time, the fiscal data from the Treasury showed that the debt rose to $33.16 trillion in 2023 from $30.98 trillion in 2022. The Treasury statement from late-2023 addresses the government’s falling revenues but also outlined the $162 billion increase in outlays for interest on the public debt being the largest single item.
RATE CUTS COMING… MAYBE!
Where short-term interest rates ultimately end up will depend upon a complicated balance of trends in financial market forces, inflation, economic growth, unemployment and actual interest rate cuts. A cut may be as simple as taking an action to lower rates — but in a financial market the real rates earned and paid are determined by the collective actions of Treasury debt buyers and sellers each day.
At the end of the day, there is no way to know if the Federal Reserve is going to cut Fed Funds in 2024. The election every November has historically created some barriers to the Fed’s desire to be aggressive on interest rates. Inflation may be stubbornly high, and the 20%-ish price hikes over the last 3-year cumulative period are not going to magically go back down to prior levels. That said, the current inflation rate is now closer to 3% even if it above the Fed’s target of 2.0% to 2.5%.
IN THE END…
There are no guarantees that long-term Treasury yields will plummet. And with the inverse relationship of a bond’s price and its yield, that means there are no assurances that long-term bond investors today will make a fortune over the next few years.
Just keep in mind that once rates do start to go lower, the big price moves on long-term interest rates will likely have already anticipated multiple more rate cuts ahead. Will that mean 2.5% long-term yields again? That’s an answer we all get to find out together.
