Real Yields Are Positive Again

Summary

• Real yields (inflation adjusted) are marginally positive making bonds a viable asset class for investment.
• A peak in long-term yields would be supportive of stock prices.
• Earnings growth is another buffer and its strength is being understated due to Amazon results.
• Depressed investor sentiment could be a springboard for a market recovery in the second half of the year.
• This idea was discussed in more depth with members of my private investing community, The Portfolio Architect. Learn More »

Torsten Asmus/iStock via Getty Images

A welcomed rally in the final hour of trading yesterday turned what looked like another midday meltdown into a sigh of relief. Stocks finished higher across the board, led by the technology sector. It was all the more impressive considering that the 10-year Treasury yield finally eclipsed 3% for the first time since December 2018. Higher long-term yields have been a major headwind for growth stocks in general and technology names in particular this year, so why the rally? I think the consensus of investors believe we may have seen an intermediate-term peak in rates after the torrid run up of more than 100% from the beginning of the year.

Finviz

The benefit for fixed-income investors is that real yields are marginally positive again. The real yield is the nominal yield of 3% minus long-term inflation expectations, which have been negative since the onset of the pandemic. Positive real yields make segments of the bond market attractive again and also create competition for stocks, but not yet in a meaningful way. I would still rather own a stock that is reasonably valued with a dividend yield close to 3% than a bond yielding 3%, but the rise in rates has created opportunities in some segments of the fixed-income markets that we have not seen since 2018. I think short- to intermediate-term corporate bonds and preferred securities now present good value.

Fidelity

The fact that bonds are now a viable asset class for investing may be one factor in limiting any further increase in yields, which is important considering that the Fed is about to launch its quantitative tightening program through which it will be dumping up to $60 billion in Treasuries on the market each month. The 10-year Treasury yield nearly doubled from 1.37% to 2.6% during the second half of 2016 in anticipation of the last QT program that ran from 2017 -2018, but that was the majority of the upward move. The peak came two years later at 3.25%.

A peak in long-term yields would help support stock prices along with the fact that we have already had a significant drawdown in advance of the Fed’s next rate hike on Wednesday afternoon. Additionally, corporate earnings continue to surprise to the upside, which is another buffer. In fact, profit growth is a lot stronger than the headline number suggests because of one megacap technology name. Amazon (AMZN) fell short of expectations last week, reporting a loss of $7.56 instead of a gain of $8.35, which can largely be attributed to a loss on its investment in EV-maker Rivian Automotive. Sales growth has also slowed relative to what it was during the pandemic when consumers spent more time at home.

The bottom line is that one very large company reduced the earnings growth rate for the entire index from 10.1% to 7.1%. Therefore, there are plenty of high-quality stocks in various sectors that are meaningfully outperforming expectations in a very difficult macroeconomic environment, and that is where investors should be focusing.

FactSet

Yet disappointments like Amazon are what has driven investor sentiment to levels we have not seen since the Great Financial Crisis in 2009. That is why I see meaningful upside in today’s market during the second half of this year.

Bloomberg

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Lawrence Fuller is the Managing Director of Fuller Asset Management, a Registered Investment Adviser. This post is for informational purposes only. There are risks involved with investing including loss of principal. Lawrence Fuller makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Fuller Asset Management. There is no guarantee that the goals of the strategies discussed by will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security.

Comments

[Swiss Maven]

@Lawrence Fuller

Real yields are positive again? With all due respect, this sounds like malarkey to me. Real yields are NOT calculated by comparing inflation expectations some distance out into the future. Scorpion Blue has it right. Real yields are calculated in the here and now, not by someone fantasizing about where nominal yields and nominal inflation rates will be 10 years from now. As Scorpion pointed out, the real yield is currently a negative 6% or so. If real yields were really positive, as the author maintains, the gold price would many hundreds of dollars lower in price than the $1,865 it is trading at today.

[Lawrence Fuller]

@Swiss Maven That's fine, believe what you like. If you want to know how economists, the Fed, wall street strategists and institutions do it, then I'm right.

[bluescorpion0]

well real yields are negative but rate expectations are low because I still see money losing biotechs at high valuations, high p/s ratio tech stocks with low or no earnings, and quality companies with p/e of 20-30x+. This is not consistent with rate expectations of 5-10-15% which would make the real yield positive.

[Swiss Maven]

@Lawrence Fuller Can you provide us a link to one wall street strategist or institution who has recently written that real short-term interest rates are positive?

[fujilomi]

So debt continues to accelerate to infinity and beyond. "Somebody" other than the FED will probably demand more and more interest as infinite/near infinite supply overwhelms finite demand. Also interest payments are already rising, causing even more problems to service infinite/near infinite debt, causing even more debt to pay that off. 3% interest on over $30.426 TRILLION and ever increasing debt comes out to over $912 BILLION EVERY YEAR. Like I said, I will be happy if there is no HYPER INFLATION rather than 3% to 5% average over 10 years. That is why I am buying I bonds to the limit, taking Jim Sloan's great advice. If less than 3% inflation on average over 10 years I will be surprised but very happy for my purchasing power, I am retired.

[bluescorpion0]

It's very interesting. notice the agenda. what you write is true. therefore the conclusion is financial repression is a certainty (i.e. inflation > interest rates). I-bonds have an upper limit. It's like a bone they throw to the dog but does not derail the master plan. If people run to bitcoin en masse they will end that game too. It's all about control to force you to 'take the pain' with no exit door. aside from covid (which may have an economic agenda), they will probably find a way to not allow moving abroad either. for example canada steals 30% of your capital to leave, therefore you still lose to inflation, outright theft. The communists in power want everyone to participate in 'taking the pain'. Some will seep through - but not many.

[David de los Ángeles Buendía]

Hello @Lawrence Fuller ,

You wrote: "The fact that bonds are now a viable asset class for investing may be one factor in limiting any further increase in yields, which is important considering that the Fed is about to launch its quantitative tightening program through which it will be dumping up to $60 billion in Treasuries on the market each month."

The Federal Reserve Bank (FRB) will not be selling any assets. If they do indeed reduce the size of their portfolio, they will do so by simply allowing the portion of their holdings closest to term to mature and not re-invest the profits. Instead they will return their profits to the United States Treasury (UST). That is, unless you mean by "dump" that the FRB will not be buying as many UST securities as in the past.

[Lawrence Fuller]

@David de los Ángeles Buendía Dump, as in someone else will have to buy them when they rollover.

[David de los Ángeles Buendía]

Hello @Lawrence Fuller ,

I do not follow you.

The whole point of "Quantitative Tightening" is not to roll over their holdings. The Federal Reserve Bank (FRB) owns United States Treasury (UST) securities, bonds, bills, notes, and so on. When those securities mature, the FRB receives money from the UST. Those securities no longer exist. What the FRB has been doing is take that money and buy new UST securities. If they rollover their holdings they do not reduce their portfolio and there is no tightening. If they are truly trying to tighten and reduce their portfolio, they will take the money that they receive from the UST and return it to the UST (minus the FRB operating costs).

The FRB will not sell any of this holdings, if they will simply not rollover their holdings.

[Lawrence Fuller]

@David de los Ángeles Buendía Trust me, I understand. When the Fed lets holdings mature the Treasury is issuing new debt to replace that which has matured. We continue to run deficits, so someone else has to pick up the slack as the fed is not buying newly issued debt.

[bluescorpion0]

real yields are Not positive. 9% inflation and 3% interest rate on 10 year and some very basic math shows it is negative 6%.

[Lawrence Fuller]

@scorpionblue That's not how Real Yields are calculated. You compare the inflation expectation for the duration of the bond.

[Luckyman1942]

I respectfully disagree. Yes, “expected” inflation is quite low. The issue is: (a) the way inflation is calculated is bias to lower the true figures and (b) the expectations are also biased to the low side on what is politically correct to say. In the end, in my humble perspective real rates are negative and will continue to be negative at least for the next 10 years.

[Lawrence Fuller]

@Luckyman1942 I have my own opinions too about what the real rate of inflation is today, but no one cares. The market doesn't care. I have to focus on what the market cares about.

[Amos Tuck]

Captain Polyana!

You've been telling people not to sell for three months now, and the market's fallen almost -15%.

Stop!

The Fed has pivoted, and is extracting liquidity.

Stock valuations were at all-time highs after the blow-off top of a manic run-up.

Stocks need to fall almost (-50%) to revert to the mean.

This isn't rocket science.

Investors need to de-risk now.

They need to take evasive action.