Are Stocks a Better Buy or Bonds With Treasuries at 5%?

The yield on 10-year Treasuries went above 5% last week for the first time since July 2007, when the first Transformers movie was topping the box office and the Dow Jones Industrial Average surpassed 14,000 for the first time in history.

Higher long-term rates are pushing many investors from stocks into bonds. The effect of interest rates on stock returns is complex, and a lot of ink is spilled arguing whether the 5% level for 10-year Treasury yields is a signal to dump stocks or pile into them. Let’s ignore the theoretical arguments and just look at the data.

where's the sweet spot

Chart 1 goes back to the Nixon Shock of 1971 (prior to that, in the gold standard days, the economics of interest rates were different). You can see here that if you buy the S&P 500 when the 10-year Treasury yield is below 4% or above 8%, you have almost always been rewarded in the past with between an 8% and a 16% annualized real (that is, adjusted for inflation) return over the subsequent ten years. Buying when the 10-year Treasury yield is around 5% has historically been the least attractive time.