Paid to Wait - Q3 2026

The stock and bond market are living in alternate realities. The stock market is enthusiastic about corporate earnings, with 86% of companies beating analysts’ estimates in the second quarter. The S&P 500 set new highs, finishing up 2.3% for the quarter. The bond market has been left out of the party. The 10-year Treasury yield rose from 4.44% to 5.29% during the quarter, and in early October it briefly topped 5.3%, its highest level in more than 20 years. The Bloomberg U.S. Aggregate Bond Index lost 3.51%. The selloff was not an American story alone. Japan’s 10-year yield crossed 3% for the first time since 1996, and France now pays more to borrow for ten years than Italy or Greece.

It is tempting to read the bond market’s mood as a verdict on stocks, or as the opening act of a fiscal crisis. We think it’s neither, and our conclusion is more encouraging than the headlines. The forces that made the past few years painful for bondholders have also made bonds more rewarding to own than they have been in many years.

The Story: It’s Not the $40 Trillion

On August 19, the Treasury reported that federal debt had passed $40 trillion for the first time. That same week, the 30-year Treasury yield briefly passed 5.3%, its highest since 2007. Financial media drew the obvious line between the two. It’s a tidy story, and it’s mostly wrong.

The problem is that this was not a surprise. With the government running deficits near 6% of GDP, the date on which the debt would cross $40 trillion was foreseeable. Markets reprice on new information. A milestone everyone could see coming is not new information.

To see what’s moving interest rates, it helps to look under the hood. A Treasury yield has two main components. The first is the real yield: what a lender earns after inflation. The second is compensation for the inflation the lender expects over the life of the bond. The Treasury does us the favor of selling both ordinary bonds and inflation-protected bonds, known as TIPS, whose yields are real yields. Subtracting one yield from the other reveals the market’s own inflation expectation.

Over the twelve months ending September 30, the 10-year Treasury yield rose from 4.15% to 5.29%, an increase of 1.14 percentage points. The 10-year real yield rose from 1.80% to 2.93%, an increase of 1.13 points. Expected inflation barely moved, from 2.35% to 2.36%. Virtually all of the increase came from real yields. This happened in a year when oil traded above $100 a barrel and consumer inflation reached 4.2% in May. The bond market looked straight through the energy shock. It is not worried that inflation will run away over the coming years. It is demanding a higher real price for money.

Worry about government debt could show up in real yields, as extra compensation for lending over long periods. The shape of the move, however, implies this is not the case. If fiscal fear were the driver, the longest-dated bonds would have moved the most, since that is where a borrower’s long-run solvency matters most. They moved the least. The 30-year yield rose 0.90% over the year. The 3-year and 5-year yields rose 1.38% and 1.35%. That middle stretch of the curve is governed by where investors expect the Federal Reserve to set rates over the next few years.

A year ago, the curve sagged in the middle because investors expected the Fed to keep cutting. Today it slopes steadily upward because they expect it to raise rates. The Fed raised rates in September for the first time since 2023, and it rarely stops at one hike. September’s increase also came over the White House’s objections. In our Q1 letter, we warned about a repeat of Arthur Burns’s error in the 1970s, a Fed that bends to political pressure and lets inflation take root. So far, this Fed has chosen otherwise, and stable inflation expectations are the market’s acknowledgment.

Real rates are rising because the economy wants to borrow more than savers want to lend. U.S. growth has repeatedly beaten expectations, and the Atlanta Fed’s GDPNow model puts third-quarter growth at 3.6%. Business investment grew at a 9% annualized pace in the second quarter, led by data centers for artificial intelligence. The five largest cloud providers spent about $330 billion on capital investment in the first half of the year and have issued $230 billion of bonds so far this year, double last year’s total.

Further adding to yield pressure is a change in buyers. At the Fed’s June meeting, its markets desk told policymakers that ownership of Treasuries had shifted “from relatively price-insensitive official-sector holders to more price-sensitive private investors.” Central banks are shrinking their bond portfolios. Pension funds that once bought long bonds almost regardless of price are giving way to retirement plans that favor stocks. The marginal buyer now negotiates, and they’re demanding a higher yield.

The Treasury department drew the wrong conclusion. On August 19, without the usual advance notice, it announced that it would at least double its purchases of its own long-term bonds, and Treasury Secretary Scott Bessent argued that yields did not reflect the underlying fundamentals. The market’s reply was clear. Yields kept rising, the dollar fell, and gold rallied. Breaking a thermometer does not change the temperature. The temperature here is the price of capital in an economy that wants a great deal of it.

There Is Now an Alternative

For most of the past fifteen years, investors were told there was no alternative to stocks. With cash and bonds paying close to nothing, that was a fair description of the choice. It no longer is.

As of September 30, the 10-year TIPS yields 2.93%, the highest since 2008. In plain terms, the U.S. government will pay an investor nearly 3% a year above inflation, whatever inflation turns out to be, for the next decade.

Compare that with what stocks offer. Since 1871, U.S. stocks have returned about 7% a year after inflation, which makes 3% look modest. But that average was earned from much cheaper starting prices. The average cyclically adjusted price-to-earnings ratio over that history was about 18, less than half of today’s. A better gauge of what stocks offer today is the earnings yield, a company’s earnings divided by its price. Using analysts’ forward estimates, as of September 30 the S&P 500 trades at 21.2x earnings, an earnings yield of about 4.7%. That leaves a premium of about 1.8% for owning stocks rather than a government-guaranteed real return.

This is not a forecast that stocks will fall. Expensive markets can stay expensive for years; valuations were already stretched in early 1997, and the S&P 500 roughly doubled before it peaked in 2000. What this says is that when stocks offer only a modest premium over a guaranteed real return, the reward for bearing equity risk has historically been thin. Today, an investor does not have to accept that risk to earn a real return. A lender is paid to wait.

Don’t Judge Bonds in the Rearview Mirror

Many investors have sworn off bonds, and it is easy to understand why. Over the past five years, the Bloomberg U.S. Aggregate Bond Index returned a cumulative -3.16%, compared to 90.6% for the S&P 500. That poor performance is precisely what created today’s opportunity. Judging bonds by their last five years is like driving by watching the rearview mirror.

A bond’s return over a year comes from two sources: the income it pays and the change in its price. When rates rise, prices fall, and when rates fall, prices rise. How far they move depends on the bond’s duration, a measure of its sensitivity to interest rates.

Consider a 10-year Treasury. In August 2020, it yielded 0.52% and had a duration of nearly 10. Today it yields 5.29%, and its duration has fallen to about 7.7. That combination works in the investor’s favor in both directions. If rates rise, the higher income and lower duration result in a much smaller loss. If rates fall, the higher starting yield leaves room for a meaningful gain, something a bond yielding half a percent could not offer.

The chart below shows the range of outcomes over a one year period. If rates rise by one percentage point, a 10-year Treasury bought today loses about 1.4%, compared with 7.9% for one bought in 2020. A two-point rise costs about 7.7%, half the 15.5% loss in 2020. If a downturn instead pushed rates down by one point, today’s bond would return 12.7%, and a two-point drop would deliver 20.8%. In 2020, that upside likely did not exist, because yields could not fall that far without turning negative.

In our Q1 letter, we explained that bonds hedge stocks well in growth scares and poorly in inflation scares. With inflation expectations anchored and real yields near 3%, bonds have recovered much of their ability to cushion a portfolio when growth falters.

Our Positioning: The Boring Corners

The best opportunities sit in the least exciting parts of the bond market. We are cautious on corporate credit. Corporate bonds pay only about 0.8% more than Treasuries, the narrowest gap in more than 25 years, and they tend to fall alongside stocks in a downturn, exactly when a portfolio needs its bonds to hold up. We prefer the middle of the Treasury curve, where the 5-year and 7-year yield 5.09% and 5.19% (as of September 30, 2026), nearly as much as the 10-year with a little over half its interest-rate risk. For taxable accounts, short-term municipal bonds stand out. A top-bracket California resident pays a combined 54.1% in federal, investment income and state tax on ordinary bond interest. For that investor, as of September 30, a 2- to 3-year California municipal bond rated A to AA and yielding about 3.2% is worth as much after tax as an ordinary bond paying 6.97% and a Treasury bond paying 5.4%.

Closing Thoughts

For more than a decade, lenders subsidized borrowers. Savers lent to governments at rates below inflation and called it safety. That arrangement is now over. The bond market is once again charging borrowers, governments included, a real price for money. That is uncomfortable for anyone who borrows. For anyone who lends, it is the best setup in many years.

We do not know whether yields go higher from here, and we do not need to. At 5%, the math is forgiving, and an investor who waits is paid to do so.

Thank you for your continued trust and partnership.

Razmig Der-Tavitian, CFA, CAIA
Chief Investment Officer & Managing Partner
Evolve Private Wealth

Please let your financial advisor know if there have been any changes to your financial situation.

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