Key insights
- The article suggests that despite strong stock market performance, particularly in AI-driven tech stocks, many portfolios may be unbalanced due to the underperformance of bonds. It highlights robust S&P 500 earnings growth and positive outlooks, contrasting with bond weakness attributed to inflation concerns and geopolitical events impacting commodity prices. The author advocates for immediate portfolio rebalancing. While the analysis provides market context, its direct forward-looking influence on US equity market direction is neutral as it focuses on investor strategy rather than predicting market movements.
As the S&P 500 (^GSPC 2.64%) has climbed from one all-time high to another over the last year, many investors have probably seen very strong returns for their portfolios. The benchmark index has climbed 27% over the past 12 months, with AI stocks leading the way. The tech-heavy Nasdaq Composite (^IXIC 4.18%) is up an impressive 39% in the same period.
But the strong performance of stocks over the past year hasn't been matched by other asset groups. For example, U.S. long-duration bonds, such as those held by the iShares 20+ Year Treasury Bond ETF (TLT 0.52%), have returned close to nothing over the past year. As a result, many portfolios may be unbalanced. Instead of waiting, investors should consider rebalancing right now.
Stocks typically outperform bonds over the long run, but the recent one-year relative performance of stocks to Treasuries sits in the 95th percentile of all 12-month periods dating back 50 years.
The stock market's performance has been extremely impressive, and for good reason. S&P 500 companies reported earnings growth of 28.6% in aggregate last quarter, the highest level since the fourth quarter of 2021, according to FactSet Research. Eighty-five percent of companies beat estimates last quarter. The outlook remains strong as well, with many analysts raising earnings expectations. They now expect aggregate earnings to grow 22.6% for the full year.
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Meanwhile, bonds have been weighed down by the challenging inflation environment. While inflation was starting to come down toward the Federal Reserve's 2% target, it has spiked in recent months because of the war in Iran. With the Strait of Hormuz closed, energy prices and other commodity prices have skyrocketed. The Consumer Price Index for April reached 3.8%, and the Federal Reserve Bank of Cleveland expects that number to climb to 4.2% for May.
Futures traders have gone from pricing in one to two rate cuts from the Fed for the year at the start of 2026 to pricing in a greater than 50% chance of one or two rate increases. That's had a noticeable effect on long-term bonds. The 30-year Treasury yield reached a 19-year high earlier this year. (When yields increase, bond prices decrease.)
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With corporate earnings outlooks continuing to improve while interest-rate outlooks worsen for bondholders, some investors may wonder why the market wouldn't simply continue down its current path. But the important thing to remember is that the market is always forward-looking. All of the expectations are already priced into the stock prices and bond prices you pay today.
It's impossible to know whether stocks will continue to outpace bonds at the level they have in the past year, but the odds are they won't. One factor to consider is the risk premium, which compares the earnings yield on stocks, the inverse of the price-to-earnings (P/E) ratio, to the so-called "risk-free rate," which is the yield on 10-year Treasuries.
Right now, the earnings yield on the S&P 500 is practically the same as the 10-year Treasury yield: around 4.5%. Put another way, investors aren't being paid any premium to take on the risk of investing in stocks.
Granted, companies typically increase their earnings over the long run. So, all things being equal, investors should expect better results from stocks over the next decade, even at today's relatively high price. In fact, the risk premium has gone into negative territory in the past. But, more often than not, the earnings yield on stocks sits above the risk-free rate.
As such, investors can expect the relative performance of stocks to bonds over the near term to fall short of the historical average. That doesn't mean you should increase your allocation to bonds, but it makes this a good time to bring your portfolio back into balance and take some gains on your stocks while buying bonds on the cheap.