Economist **Jeremy Siegel** assessed that the real yield on the 30-year inflation-linked U.S. Treasury (TIPS) has risen to around 3.35%, reducing the excess return stocks had been offering over bonds to about 1.65 percentage points.
Key points
Siegel noted that the real yield on 30-year inflation-linked Treasury bonds was this high only about 20 to 30 years ago.
He argued that rising interest rates put much more pressure on thin-margin (low-profit) companies than on mega-cap tech stocks.
He is demanding two more increases in the Fed’s benchmark interest rate before the end of this year, including a 0.5 percentage-point hike in December.
Siegel’s ‘bond math’
Siegel, the senior economist at **WisdomTree** and the emeritus professor of finance at the Wharton School, said in a TV interview that the real yield on 30-year TIPS is “at a level we haven’t seen in the past 20 to 30 years.” These bonds (TIPS) are structured to pay a fixed real interest rate on top of the inflation rate. Interview excerpt
Based on Siegel’s calculations, if the stock market is trading at a price-to-earnings ratio (PER) of about 20, the real expected return that exceeds inflation is roughly 5%. If you then plug in the current TIPS real yield (about 3.35%), the additional compensation stocks provide over bonds comes to only about 1.65 percentage points. He explained, “Stocks still have the advantage, but the gap is narrowing quickly.”
Nominal Treasury yields are also rising sharply. The yield on the 10-year U.S. Treasury climbed as high as 5.33% on Thursday intraday, the highest level since 2002, before easing to around 5.24%. The 30-year Treasury yield also hit the highest level since 2002. With persistent inflation, large-scale fiscal borrowing, and a solid growth outlook overlapping, the environment is supporting expectations for higher interest rates and longer-term fixed-rate returns.
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The ultra-high profit margins of the ‘Magnificent 7’
Siegel estimated that the operating margins of the mega-cap technology-stock group known as the ‘Magnificent 7’ range from 50% to 70%, while the margins of non-technology companies are around 7% to 10%. Therefore, when borrowing costs rise, the impact is far greater on companies with thinner profit margins, and he said this factor is preventing a ‘rotation from the big-tech-dominated rally that has been going on since the first half’ into mid/small caps and value stocks.
According to market research firm **FactSet**, about 75% of S&P 500 constituent stocks fell during the month of September.
Fed outlook: “Twice more this year, 0.5%p in December”
Siegel argued that the Federal Reserve should raise the benchmark interest rate two more times before the end of this year. This is a more hawkish view that exceeds the Fed’s own “one additional increase” outlook presented in its dot plot. He said that in the October 27–28 FOMC—ending six days before the midterm elections—when Chair **Kevin Warsh** is set to finish his term, the Fed would likely opt to hold rates steady, and instead consider a 0.5 percentage-point ‘big step’ at the December meeting.
However, the Fed leadership’s official messaging is more cautious. Deputy Chair **Philip Jefferson** said in a Thursday speech that the other commissioners need more time to assess the data before deciding on the next move. Earlier, in mid-September, the target range for the policy rate was raised to 3.75% to 4% with a 0.25 percentage-point hike. Full remarks
In the futures market, the probability of an additional rate hike in October reportedly has plunged from around 70% just a few days ago to about 25% now.
Siegel has been monitoring the process of shrinking stock excess returns over the past few months. In early June commentary, he estimated that real interest rates at the time were roughly around 2%, giving stocks an advantage over bonds of about 2.5 to 3 percentage points. Then, on September 28, in a weekly note, he said that the real yield on the 10-year Treasury rose by nearly 40 basis points in just three weeks, approaching 2.8%, adding that “bonds have re-emerged as a very powerful asset class competing with stocks.”
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