Stocks are priced to deliver half of their historical average returns. Treasury Bonds continue to offer below average returns. Only short-term Treasury Bills offer significantly higher returns than normal. The relationships in the graph above are what Bill Gross, the "Bond King" just up Pacific Coast Highway, had in mind when he penned his July Investment Outlook. He subsequently made a media appearance on Bloomberg reiterating and expanding on his views. Here’s Bill from his Outlook:
"The recent bout of near hyper-inflation was really a joint creation of an oblivious Fed, and a 4-trillion-dollar-plus Covid fiscal policy that continues to feed consumer spending. This positive correlation of higher deficits and tighter monetary policy with a lag have produced an increase in the Treasury 10 year of 325 basis points from its 2021 bottom. But with inflation back to 3% or so and the Fed nearing the end of its tightening cycle, it would appear to many that a new bond bull market is about to begin. While I think that the 10 year at 3.80% may have peaked at 4% for 2023, a bull market is not in the cards.
(1) While the Covid fiscal deficit of 3 trillion-plus is now a more reasonable $1 trillion, the $1 trillion is still higher than that during the Great Recession. Supply and the current Quantitative Tightening (QT) program by the Fed, promise to keep yields above 3.5% for a long, long time. Medicare, Medicaid, and Boomer Social Security benefits will floor the 10 year near current levels.
(2) If Jay Powell’s goal of 2% inflation is achieved, a 2.5% Fed Funds level (.5% real) historically has led to a +140 basis point spread for the 10 year over FF, what is commonly known as the “term premium”. That suggests 3.9% for the 10 year at 2% inflation. The market at 3.75% is already there and then some. If 2% inflation cannot be achieved and sustained then 2024/2025 may see 4%+ yields."
In the Bloomberg interview in August, Mr. Gross observed that if the Fed decides to tolerate 3% inflation the 10-Year US Treasury should settle in at about 4.4%. The 10-Year US Treasury Yield is currently below that rate, giving the Fed credit for successfully vanquishing inflation, and then some.We agree with the founder of PIMCO, who began his investment career by counting cards in Black Jack, much like Ed Thorp, and my Dad. We are big fans of US Treasury Bills. We continue to keep our duration short in our bond portfolios. And while we remain surprised by the stock market’s persistent optimism, we continue to stick to our valuation and trend disciplines, and wait for the market to decline and offer better returns before fully allocating to the stock market.