As inflation-adjusted U.S. bond yields climb to their highest levels in nearly 15 years, some investors are wondering whether owning stocks is still “worth it” over the long haul.
The answer, according to University of Pennsylvania Wharton School finance professor Jeremy Siegel, is, “Yes, absolutely.”
Long-term gains for stocks have historically outpaced those for bonds by a substantial margin, even during periods in markets history where yields were much higher than they are today. Siegel argued that’s reason to ignore short-term price fluctuations, including the selloff that has caused the S&P 500
SPX
to trim its year-to-date gain by roughly five percentage points over the past three weeks, according to FactSet data.
And with higher interest rates and stronger workforce productivity expected to become permanent features of the U.S. economy, Siegel says the outlook for stocks compared to bonds is becoming more compelling, not less.
“Certainly the gap between bonds and stocks has narrowed from what it has been in recent years, but there’s still a decided advantage to owning stocks,” Siegel said Monday in a phone interview.
Meanwhile, as investors wait to hear from Fed chief Jerome Powell on Friday, Siegel said he doesn’t expect much of a market reaction, likely because the central bank still has a month’s worth of economic data to digest before its next meeting.
However, he’s curious about whether Powell will weigh in on signs that economic growth in the U.S. is accelerating.
The following is an edited and condensed version of MarketWatch’s interview with Siegel:.
MarketWatch: What do ordinary investors misunderstand about the long-term benefits of owning stocks compared with bonds?
Siegel: Let me mention that 2% a year [on inflation-protected 10-year Treasurys
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] is good, it’s the biggest in more than a decade. But at that rate, it takes 36 years to double your money. At a 20 price-to-earnings ratio for the S&P 500, you get a 5% yield on real assets. That means with stocks, it will take 14 years to double your money after inflation. In other words, by the time you’ve doubled your money in bonds, you’ve multiplied it by nearly five times in stocks. So, people who tell me bonds are as good as stocks — there’s just no way, for long-term wealth creation.
Does that mean investors should ignore those big, fantastic yields on the 2-year note? 5% on the 2-year note comes out to 2%, or maybe 3%, after inflation. In two years, anything can happen. The stock market could go down by 10% or 20%. But I’m not talking about the short term, I’m talking about longer-term wealth building, particularly if you’re young and you’re building a retirement account. That’s what really counts.
And 2% after inflation is only attractive compared with recent history. When TIPS [Treasury Inflation-Protected Securities] first came out in 1997, they were at 3.5% and then went above 4%. While 2% is certainly better than five or 10 years ago, it’s still not all that great compared with history.
MarketWatch: What’s the case for sticking with stocks through periods of elevated inflation?
Siegel: I think this is important because a lot of people are confusing yields on bonds, which are nominal yields, which means they do not factor in inflation, with stocks, which are based on real assets like land, property, machines, trademarks, copyrights, the value of which does rise with inflation.
If you’re planning a long-term portfolio, a retirement portfolio, a portfolio for a young, working person or child, the advantage in stocks is still overwhelming.
The two assets that will over the long run beat inflation are real estate and stocks, because they’re both real assets. That’s why both of them are viewed favorably now. I want to hold real assets, I don’t want to hold paper assets.
MarketWatch: Where do you think interest rates are heading over the long term?
Siegel: One of the things you learn is real interest rates do track real growth. With population growth falling, productivity over the last few quarters had been way down. But now productivity is improving, and rising productivity and stronger growth mean the Fed won’t be able to cut rates as much as it would otherwise be able to. It may only be able to lower them to 2.5% or 3%, or maybe even 3.25% on Fed funds [the Fed’s benchmark policy rate target]. When all this is over, then you might be seeing 3% or 3.25% long term on Fed funds.
MarketWatch: What do you think we’ll hear from Federal Reserve Chairman Jerome Powell later this week when he speaks at Jackson Hole?
Siegel: There’s a lot of tension and Powell has moved markets in the past. I do not think that the inflation scenario has changed that much from 3½ weeks ago when we heard Powell in his news conference following the last FOMC [Federal Open Market Committee] meeting.
There’s still a full month of inflation data, of payroll data, before the September meeting and Powell said they’re going to be data dependent. As a result, his talk may disappoint those who are expecting a big market-moving event.
See: Jackson Hole: Fed’s Powell could join rather than fight bond vigilantes as yields surge
I think he will basically say their work is not yet done. They’re not down to where they need to be. However, they have made a lot of progress, the labor market has slowed but GDP hasn’t because, as I mentioned, there’s been a huge surge in productivity.
And when productivity growth spurs GDP growth, it isn’t inflationary, in fact, it’s deflationary.
We will see how Powell interprets the positive news on growth. I hope he doesn’t fear it to be inflationary. I hope he recognizes that the rise in yields will slow certain industries, particularly housing…that’s further reason he shouldn’t move up the short-term rate because the long-term rate is doing some of the work for him.
MarketWatch: Speaking of Powell, how many more hikes do you expect we’ll see from the Fed?
Siegel: Right now, Powell is very self-satisfied because even the Fed is surprised at the fact that the labor market has remained strong and GDP growth has remained strong, despite these rate hikes. If we get a negative jobs report, you know what the press will do with that. However, as long as these reports continue with 200,000 [jobs created a month], with unemployment remaining stable, there’s no downside for him to keep on hiking if he wants to. The public doesn’t see a connection until they see a connection.
But in my opinion, if you ask the American public whether they would rather have 1 percentage point or two percentage points less on inflation for a year or two, or have a million or a million-and-a-half more unemployed, they’re going to say that while they’re not happy with the price increases, that that would be the better option.
If we do see a slowdown and Powell keeps on going up and up, I think there will be a negative payroll report and that will grab headlines. Then, Powell’s phone will be ringing off the hook with angry Democrats. They’re riding on this fact that we’re slowing inflation without unemployment. If that disappears, a major part of their case for re-election is threatened.
My feeling is that, especially considering the rise in long-term rates, that the Fed shouldn’t raise rates again. Then again, if they raise rates another quarter of a percentage point, would it be the worst thing in the world? No — so long as they’re extremely responsive, and keep a close eye on the real-time indicators showing that things are slowing. These are the things that they ignored in 2021 — unforgivably, in my opinion — that should have told them that this was a permanent, not a transitory, rise in inflation.
I’m talking about commodity prices falling, home prices falling, initial jobless claims going up. These are the very early warning signs of a slowdown. And Powell has said he’s become more appreciative of real-time data.
MarketWatch: How do you feel about the notion that “r-star” — or the neutral rate of interest — has moved higher for good, and as a result, we won’t be seeing rock-bottom interest rates again soon? The Wall Street Journal discussed the concept in a story published over the weekend.
Siegel: I’ve actually written a bit on this. There are several reasons for it. One of them is faster economic growth. Last December, almost nobody expected GDP growth of 2% or higher. The Fed was at 0.9%, optimistic people were at 1.5%. Now, of course, the expectation is for the third quarter we could see growth north of 2.5%.
Faster economic growth, in and of itself, causes r-star to increase. Another reason r-star is rising is that bonds are not as attractive as they once were. For 40 years, bonds were a great hedge against financial risk and stock market risk. During the pandemic, when the market tanked, Treasurys rose. Same thing during the financial crisis [Editor’s note: bond yields move inversely to prices, rising as yields fall].
But as we saw last year, bonds are terrible hedges when the Fed has to fight inflation. Investors’ perception of the quality of bonds as a hedge on stocks is important because that can raise r-star.
During the bad old days of the 1970s, we had 9% to 10% inflation for a decade. We’re nowhere near that now, but bouts like we just had could happen again, and it’s not something you want to be holding bonds for. Plus, global supply-chain on-shoring, environmental requirements and other factors are going to probably add an upward bias to prices, as well as the federal deficit. After all, how do countries get out of debt problems? They don’t default, they inflate.
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