Buy Stocks or Bonds? The Answer Might Surprise You.

While no environment is truly risk-free, as Mark Haefele, chief investment officer of Global Wealth Management, writes, a lot has gone right in recent months: “[I]nflation has receded, meaning the Fed and other major central banks are closer to the end of their tightening cycles. The U.S. labor market has cooled, but not so much as to push the economy into a recession. Earnings have improved, with U.S.-listed company profit expectations now back at all-time highs.”

That benign backdrop “creates an opportune moment for investors,” he notes. He expects major global stock market benchmarks to notch returns of 8% to 10%, and returns from high-quality bond indexes of 10% to 15% by the middle of next year.

Of course, investors who are prone to worry don’t have a shortage of fodder, from a potential government shutdown this fall to the ongoing high cost of living that’s squeezed consumers. And cash has appeal: Even with interest rates likely to moderate over the next 12 months, right now risk-free cash in high-yield savings accounts is approaching 5%.

Nonetheless, has Haefele writes, right now risks are fairly manageable and the outlook is bright, meaning investors should move off the sidelines. “Overall, we think the macro backdrop suggests a combination of higher growth and lower inflation than had seemed possible a few months ago. The Fed now faces less pressure to hike rates further, and rising real wages are reducing the economic pain from earlier rate hikes.”

As for specific asset classes, he argues that this sets up bonds, which have lagged this year, to ultimately shine. Still-high yields mean investors can lock in attractive interest rates, while a more moderate outlook for future rate hikes means that investors in quality bonds are unlikely to endure any mark-to-market losses (as would happen if future notes carried much higher yields that devalued bonds paying today’s rate).

Bonds are likely to look even more attractive as economic growth gradually decelerates (the soft landing scenario). In fact, with his projected total returns of 10% to 15% for both high- and investment-grade bonds over the next six to 12 months, they are Haefele’s most preferred asset class.

Yet investors shouldn’t discount equities, either; he notes that there are “more significant downsides” to stocks, and in the case of a slowdown, major U.S., developed and developing nations’ benchmarks would likely see double-digit declines. However with ongoing optimism about the transformative power of artificial intelligence, and growing profits supporting expanding valuations, the
S&P 500’s
big year-to-date gains look justified.

While Haefele is less enthusiastic about equities at the moment, compared with bonds, he’s still modeling for that 8% to 10% base-case return rate over the next six to 12 months, which could reach as high as 17% to 19% in a blue-sky scenario.

Those figures alone should be enough to remind investors to avoid the temptation to park everything in ultrasafe cash, even if they’re earning much more interest on their savings accounts than they were in past years, particularly as many economists expect interest rates will decline again in the not-too-distant future.

Haefele notes that last year’s simultaneous declines for stocks and bonds is historically rare; by contrast, diversification can take the sting out of near-term volatility across asset classes and deliver higher long-term gains.

“Overall, we expect cumulative cash returns of just 5% to 14% over the next five years, versus cumulative returns of 15% to 25% from high grade bonds, 40% to 55% from global stocks, and 25% to 65% from alternatives,” he concludes. “We believe that by developing a core allocation of investments carefully balanced across asset classes, investors can both position to earn attractive returns over the short and longer term, and effectively protect themselves against potential market risks.”

Write to Teresa Rivas at [email protected]