Bond Yields in 2022
Bond yields in 2022 are rising and making bonds somewhat interesting again.
Our friend, the bond lost a lot of luster after the 2008 recession. A recovery in stocks combined with downward rates and easy money policies shifted a lot of money away from bonds and into stocks.
After all, why buy a 20-30 year bond that pays you 1-2% with no potential for growth when even at a 33 P/E ratio, a stock has an earnings yield of 3% earnings yield with long-term potential for growth.
Was it that big a surprise when stocks kept churning along into P/E ratios even if it made many investors uncomfortable?
Then our friend inflation happened and the fed had no choice but to start raising rates to combat it and when rates are raised, bonds ultimately follow their lead. Suddenly, bond yields in 2022 started to look good especially on the shorter end of the scale.
As I write this, the 1-yr treasury bond yields almost 3.5%, the highest its been since the early 2000s and a decent bump over the last time we saw bond yields rise in 2018 when we also saw a market dip.
That wasn’t a surprise because bond yields and stock prices often move hand in hand. After all, money has to flow somewhere and stock valuations don’t exist in a bubble. The 2018 market dip didn’t last long as rates started falling right after but who knows what happens from here.
Just like last time, the recent market turbulence comes at a time when investors have some alternatives again.
In the past few years, a 33 P/E stock with its 3% earnings yield looked good against most other assets. Cryptocurrency with its dynamic pricing gains looked interesting to investors looking to build wealth. Real Estate was the same combined with the low mortgage rates.
All that was because cash was worthless and bonds basically yielded nothing.
Well, now that’s changing. Even my money market funds in my Vanguard or Fidelity accounts are now yielding 2%+ and IBonds offer investors a short term 9%+ return to mirror inflation. Bond yields in 2022 are also starting to get enticing because even though they are still negative in real terms but the hope is that inflation is short term and these yields can be locked in for multiple years even after inflation recedes.
The 20 year yield at 3.6% still doesn’t seem all that great when inflation is this high but its certainly getting interesting. What will happen if the fed has to keep raising rates and that number keeps creeping up.
Investors can now get 2.5%-3.5% in 1 month to 1 year bonds and that certainly looks solid when compared to the volatility and uncertainty that exists in today’s market.
It’s no surprise that the rising yields that started in the early part of 2022 coincided with a downward move in stock market prices. As alternatives get more enticing, the stock market gets repriced as money flows out of it. The 3% earnings yield that seemed appealing a year ago is no longer all that appealing when bond yields in 2022 are still searching for a top and are already yielding more.
Sure, there’s no hope for growth if you buy those now but short-term growth might be a question mark in stocks too given market conditions and economic uncertainty.
That has led to stocks that now trade at much more favorable multiples yielding closer to 4-5% on an earnings basis assuming earnings continue to grow. That still makes them more appealing than bonds but it’s unclear how long that continues and whether rising bond yields or shrinking earnings will force those multiples and/or prices even lower.
After all, inflation is still a problem which impacts main street as well as wall street and might force the fed to continue aggressively raising rates.
Now, it’s important to remember that these bond yields already reflect certain assumptions around that happening. Right now, those assumptions seem to lean towards this being a short term issue due to the fact that 1 year yields are now higher than 10 year yields.
However, that doesn’t mean that’s correct and if those assumptions are wrong and bond yields keep rising across the board then stocks could be in for some more hurt in the future.
After all, while 3.5% bond yields might not be that enticing right now against stocks, what happens if those rates are suddenly 5% or 6% like they were in the early 2000s. Luckily, stocks now don’t have the same crazy multiples like they did back then so a massive crash like that is unlikely but you can never predict the future and a recession could make those multiples irrelevant if the earnings part of the equation suddenly shrinks by half.
Bonds have certainly fallen out of favor in recent years but there’s a reason they exist and it’s to provide some stability to a portfolio.
While bond funds have lost value in terms of prices due to these rising yields, the future income they will provide is now rising as well and making them more interesting. It’s quite possible they get even more interesting if yields keep rising.
My portfolio has a 7.5% allocation to bonds and these have been in short term bonds in recent years due to the lack of yield and the high likelihood that those would rise someday. After all, when you’re at 0, there’s not much lower you can go.
While I have some seen some price reductions even in those funds, it’s been a lot more limited than long term funds and now the rising yields are starting to make the income generated by those funds a lot more impressive. Since the short term rates have moved in lockstep with long term rates, I didn’t miss out much by keeping my allocation to short term bonds. Some allocation to TIPS has also been a boon to my income and has provided some stability to my portfolio totals as inflation rises.
Another nice thing is that as stock prices drop, my allocations automatically reflect that and money gets funneled into whatever looks more attractive at the time simply on the basis of which assets are under allocated. It takes away the emotion out of investing and I can invest simply based on the data. That’s the nice part of having a preset asset allocation when you start investing.
It was just a few years ago in posts like this that I was talking about how stocks have run away in my asset allocation and I was buying bonds even if it didn’t feel like the right thing to do. Well, now I know that how things feel doesn’t matter because buying bonds at the time end up being the right move to make.
Now that these assets have been re-priced due to rising bond yields, stocks have taken that place.
It now doesn’t feel great to buy stocks that keep dropping in price but from a comparable perspective, right now, stocks seem more fairly valued because you can finally find good long term stocks and ETFs that are priced below a 20 P/E which drives a 5%+ earnings yield. That’s not a guarantee in the short term because earnings can drop but it should be fine if you’re investing for the long term.
That may certainly change if bond yields keep rising. For short term goals, I bonds and short term treasuries seem like the right move right now.
Despite the turbulence across the board, it is nice to finally see bonds become more valuable and drive better income for those who need it. Hopefully inflation slows down because even at 3%+, they yields right now are not positive real yields and that’s a problem if that continues for the long term.
With all that said, let’s dive into the income report for August 2022. Last August, my dividends came in at $336.79 so let’s see where we are now.
August’s dividends came in at $534.36 which is a 58.7% bump over last year.
That’s a pretty huge bump and driven partially by that improved income from a few bond funds that pay monthly. While bond funds technically don’t pay dividends, they pay interest, it’s still income to me so I’ve always tracked them as such. It’s also nice because I can always re-invest that income into stock funds when my asset allocation calls for that.
The rising yields this year could potentially make some of these off months are lot more impressive when it comes to growth as these yields have started to spike in recent months. Add to that my increasing monthly dividends in my M1 Finance accounts and baby you’ve got a stew going.
Bigger months mean more forward income as well due to all this money being re-invested in securities that pay dividends at a higher forward yield. It’s not a lot but this’ll boost forward income by $16.57. Compound that with the money I invest in the market each time I get paid and things are looking good.
That’s not to say dividends are guaranteed to grow. After all, if we have a recession then not only will prices drop but so will dividends and income as well as the fed can always pivot to cutting rates. Even in 2020, an ETF like VOO which mirrors the S&P 500 actually saw a reduction in dividends and the 2008 recession saw a nearly 20% drop in dividends so that’s something to keep in mind.
However, in the long run, dividends should grow as will stock prices even if it takes a few years to recover like it did after the 2000 crash or the 2008 recession.
Steve, my dividend employee, earned $3.21/hr. this month bringing his hourly wage for the year to $6.01/hr. It’s not quite minimum wage but it’s solid growth.
For the year, my dividends sit at $8,014.84, a 11.2% boost over this time last year. Hopefully, I can see big bumps like the one this month more regularly in these small months which should help the yearly growth rate a bit.
I’ve still got two big months up ahead including September which is always a nice one given my investments in various ETFs and index funds that pay quarterly. You can see what’s ahead in the graph below.
September is sizable but it’s December that really brings the results each year. However, since these are bigger starting points, the growth rate in those months likely won’t be as high as some of these smaller months.
Overall, the growth this year is solid but not amazing given that inflation is near double digits. Bond yields in 2022 are rising which should mean good things for these off months as evidenced by August.
While bonds are getting more interesting, stocks have seen a downturn that has made them more enticing as well. Prices are down quite a bit which brings P/E ratios and free cash flow yields into reasonable territory. My asset allocations are now telling me that it’s a better time to buy stocks than bonds based on historical norms but that doesn’t mean stocks are at an absolute bottom nor that they’re an amazing value right now.
That bottom is always tough to time but if bond and cash yields keep rising then stock valuations might have more room to fall as those often move hand in hand.
As a bond investor, it’s always nice to see more income come from those holdings. It might be confusing to see bond funds drop in price but that is to be expected as yields rise and the current holdings of those funds become less valuable due to those lower yields being less than what new issues are offering..
However, future buys in those funds will now have these higher yields and generate more income which should help them catch up. Inflation remains a problem but hopefully a short term one because bond yields are still far below those numbers and not generating positive real returns.
It’s certainly an interesting time to be an investor and it might get worse before it gets better but since I have a long term mindset, I’ll keep buying and enjoying the lower prices for now. After all, at some point in the future, today’s prices will likely seem like a bargain.
However, it wouldn’t surprise me if we have more volatility ahead. I do have more cash in hand right now than usual but have been deploying cash here and there and keep investing with each paycheck as well as timing the market is not my thing outside of my active portfolio which is a small % of my overall investments.
Thanks for reading and hope your August was a good one.