Soaring U.S. Treasury yields are further boosting the appeal of bonds over stocks, deepening an already painful equity selloff while threatening to weigh on equity performance over the long term.
As a result, many investors are recalibrating how big of a role stocks should play in their portfolios. Fund managers have been overweight bonds for eight out of 10 months of 2023 and are currently above their average historical allocation, the latest survey from BofA Global Research showed. At the same time, they are underweight stocks.
Rising bond yields raise the cost of capital for companies, threatening their balance sheets. Tesla CEO Elon Musk said last week that he was concerned about the impact of high interest rates on car buyers. Historically, the S&P 500 has shown average 12-month returns of less than 6% when the ERP falls below its average, Lynch said. In contrast, when the market’s ERP surpasses that level, forward returns approach 12%.
Current equity valuations also may be banking on overly optimistic earnings estimates, if the higher interest rates slow the economy as many analysts expect. John Hancock Investment Management is recommending a modest overweight to bonds. Similarly, LPL Financial also is recommending a modest overweight to fixed income.Analysts at UBS Global Wealth Management said in a note this week that the level of the equity risk premium “does not look alarming,” noting the level was even lower from 1980 to 2000.
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