At 5%, Bonds Become Real Competition for Stocks

For most of the past 15 years, investors had a relatively easy argument for owning stocks: There weren’t many attractive alternatives.

Bonds returns have been muted or negative over much of the past decade. Crypto has been volatile. The dollar has been up and down. Except for the past two years, international stocks and bonds haven’t been meaningfully attractive for quite a while.   

That may be changing.

The yield on the 10-year U.S. Treasury is now approaching 5%. At that level, stocks have much stronger competition for investor dollars.

Why the 10-Year Treasury Yield Matters

Think about the decision facing an investor: If relatively safe U.S. Treasury bonds yield 2%, earning 7%, 8% or 10% from stocks is a no-brainer.

But what if Treasuries yield nearly 5%?

Suddenly, investors can earn close to 5% without taking the same business and market risk associated with stocks. Stocks need to offer enough additional expected return to compensate investors for taking that additional risk.

At the same time, higher Treasury yields generally mean higher mortgage rates, corporate borrowing costs and financing costs throughout the economy.

That’s a tougher environment for businesses, and ultimately for stock valuations.

The Bond Market Is a Giant Seesaw

When investors sell Treasury bonds, bond prices fall. As those prices fall, their effective yields rise.

When investors buy Treasuries, the opposite happens. Increased demand pushes bond prices higher, which pushes their yields lower.

Bond prices and bond yields move in opposite directions. Like a see-saw.

That means one potential solution to today’s rising-yield problem is actually fairly straightforward: buyers need to return to the bond market.

That could be individual investors deciding that 5% Treasuries look attractive. It could be pension funds, banks, insurance companies or foreign governments. And, under extraordinary circumstances, it could eventually include large-scale purchases by the Federal Reserve.

We recently saw just how difficult it can be to push yields lower when Treasury Secretary Scott Bessent announced plans to increase purchases of longer-term Treasury bonds. Initially, it worked: buying increased demand, bond prices rose and yields fell. But the move quickly reversed and yields climbed again… the bond market effectively called Treasury’s bluff.

The lesson is important: the government can influence bond prices, but it can’t easily overcome the underlying reasons investors are demanding higher yields, including inflation concerns, rising energy prices, and increasing uncertainty around U.S. debt.

What Could Change the Story?

Ironically, the cure for high yields may eventually be high yields.

At some point, Treasuries become attractive enough that investors start buying them aggressively.

More buying = higher bond prices.

Higher bond prices = lower Treasury yields.

Lower Treasury yields = lower borrowing costs and less competition for stocks.

That’s one reason I’m watching the 10-year Treasury as closely as the stock market itself. A move back toward 4% could become a meaningful tailwind for stocks. A sustained move above 5% could create the opposite.

Stocks are still up low double-digit returns year-to-date; the investment case still attractive, even if valuations appear stretched. As I wrote in my recent article, I still don’t see a great case for a large allocation to bonds. However, they absolutely have a place in the allocation because it’s important for long-term success to make money wherever possible at all times.

For investors, the takeaway isn’t to predict which happens next. It’s recognizing that for the first time in a long time, bonds may be offering enough return to matter and the battle between stocks and bonds for investor dollars may have a hand in determining where markets go from here.

Clients of Life Moves Wealth have exposure to bonds in various forms and are positioned to benefit from these shifts over time. If you’d like a complimentary review of your investment strategy, risk, and opportunity, please reach out.

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