"Rates Are Rising, but Stocks Are Better?"... AI Reshapes Existing Investment Formula [Weekend Money]

Simultaneous Decline in Stocks and Bonds
Corporate Earnings Improve Amid AI Investment
“Increase Gold and Cash Allocation for Hedging”

Despite the recent surge in long-term interest rates, stocks are now considered more attractive investments than bonds. In the past, bond prices typically rose when stock prices fell, helping to offset portfolio losses. However, more recently, stocks and bonds have tended to move together, undermining the traditional "portfolio safety net" role of bonds. Meanwhile, the surge in corporate investment, especially in artificial intelligence (AI), is driving increasingly optimistic profit forecasts in the stock market.

Ha Jaeseok, a researcher at NH Investment & Securities, assessed, "The required risk premium for bonds is rising due to increased supply-and-demand pressures and a weakened risk-hedging function in portfolios."

The 'Bonds = Safe Assets' Equation Is Broken... Term Premium on the Rise

First, the "term premium"—the additional compensation investors require for holding long-term government bonds—is increasing. Investors are now demanding higher rates to tie up their money for 10 years compared to the past. The ongoing Russia-Ukraine war, along with continued geopolitical risks in the Middle East, are also adding to supply-side uncertainties.

Deterioration in supply-demand dynamics is another key factor eroding the appeal of bonds. Major countries are increasing fiscal spending and accumulating more debt, while the volume of ultra-long-term corporate bonds issued by big tech companies to fund large-scale AI infrastructure investment has also soared. Additionally, reductions in holdings of U.S. Treasuries by major countries such as Japan and China, combined with moves by global public pension funds to decrease their government bond allocations, have all contributed to greater supply pressures on U.S. Treasuries.

On the other hand, the stock market continues to show solid earnings improvements, even in this high interest rate environment. NH Investment & Securities estimates that data center investments by leading cloud companies such as Amazon, Alphabet, Meta, and Microsoft will exceed USD 1 trillion this year. Consequently, the 12-month forward earnings per share (EPS) projections for the S&P 500 continue to trend upward.

Researcher Ha noted, "Short-term interest rates, which are sensitive to monetary policy, are lower now compared to 2023, when the U.S. 10-year Treasury yields were at similar levels," adding, "There is no clear correlation between the term premium and stock market valuations." In other words, it is difficult to conclude that elevated interest rates alone will necessarily lead to a decline in stock market valuations.

"If Bonds Can't Protect, Fill the Gap with Gold or Cash"

He also advised looking beyond bonds to other assets as tools for risk hedging. Given the macroeconomic environment, the likelihood that the correlation between stocks and bonds will weaken in the short term is low.

In fact, portfolios that replaced a portion of the traditional 40% bond allocation in the classic 60% stocks/40% bonds portfolio with gold or cash have delivered better risk-adjusted returns.

Ultimately, as long as corporate profit growth continues, equities should retain their relative appeal from an asset allocation perspective. Researcher Ha added, "While interest rate volatility continues to pose risks, the relative investment appeal of stocks over bonds is likely to persist."

This content was produced with the assistance of AI translation services.