The Research Affiliates’ formula says that with bond yields surging to 4.7%, T-notes seem like a better deal than the expensive S&P

(SeaPRwire) –   This reporter’s primary resource for identifying global investment categories with the most promising future returns is a feature on the Research Affiliates website known as Asset Allocation Interactive. Research Affiliates manages $188 billion in investment strategies, primarily for mutual funds and ETFs, and provides the methodologies for its RAFI funds offered by Invesco, Charles Schwab, Pimco, and State Street. The firm’s chair and founder, Rob Arnott, a former editor of the Financial Analysts Journal, is highly respected in academic circles; his firm attracts top finance PhDs. Crucially, the formula Interactive uses to project future gains is straightforward, convincing, and grounded in fundamental market mathematics. Its core message can be summarized as: “purchasing assets at excessively high prices typically leads to poor future performance, and vice versa.”

This principle is rarely heard on Wall Street, yet it serves as a valuable guide, especially amidst the current market fervor that propelled the S&P to an all-time high on May 14—after a 22% gain over the past year on top of an already elevated valuation.

The Asset Allocation Indicator is heavily influenced by this dynamic: the significant increase in yields has made traditionally unexciting but very safe Treasuries—the 10-year recently reached 4.7%—much more appealing, while the surge in U.S. large caps has made that asset class as a whole an extremely poor investment. The stark contrast between the diminished prospects for equities and the increased attractiveness of fixed income is so pronounced that Treasuries and even cash appear to be a better option than the S&P 500 generally, let alone the “Mag 7” stocks.

Why large-cap technology stocks rank lowest among current investment options

Asset Allocation Interactive projects future returns over the next decade for approximately 40 asset categories. This broad spectrum includes Global Corporates, U.S. High-Yield, and TIPs on the bond side, and for stocks, separate growth and value portfolios in both developed and emerging markets, further categorized into large and small caps, as well as U.S. REITs and diversified European holdings.

To calculate expected annual stock gains, the Interactive combines the current dividend yield with projected EPS growth, and adjusts for changes in valuation—incorporating a reversion to the mean for the P/E ratio. Specifically, the formula projects that from its current starting point, the multiple will either decrease or increase halfway back to its historic average over the next decade. Notably, this is a conservative approach in today’s market, as the S&P’s P/E is so far above its norm that even a 50% decline would still leave it in elevated territory.

According to the Interactive, U.S. Large Caps are expected to deliver a meager 3.2% yearly return from now through May 2036. Adjusted for an anticipated inflation rate of 2.6%, this translates to a “real” advance of just 0.6%. The outlook is even bleaker for U.S. Large Cap Growth, which is projected to advance a paltry 1.7% annually, lagging the CPI by almost 1 percentage point! In fact, among all the more than three dozen classes on the Interactive, U.S. Large Cap Growth finishes last. This grouping is, of course, dominated by the “Mag 7” stocks, which effectively account for its poor ranking. Collectively, these high-flying tech companies boast a massive P/E multiple of 38, and the Interactive’s model anticipates these P/Es are due for a decline.

What is particularly sobering, and contrary to the advantage equities have held in nearly every other period, excluding a couple of unusual interludes, is this: not only Treasuries but also “Cash” are projected to significantly outperform the S&P 500 (U.S. Large Cap) and especially crush the market’s most celebrated segment, Large Cap Growth, exemplified by companies like Nvidia, Alphabet, and Tesla. A portfolio of Intermediate Treasuries with maturities between 3 and 10 years would yield 4.6% annually, beating inflation by almost two percentage points. Even opting for “Cash,” by investing in 30-day commercial paper, would return 3.5% and exceed the cost of living by 0.7%.

Therefore, Research Affiliates predicts that Treasuries will provide nearly three percentage points more than Large Cap Growth (4.6% vs 1.7%), and buying Commercial paper will also perform better (3.5% vs 1.7%). Furthermore, the Interactive highlights numerous global opportunities where returns should easily surpass Treasuries or cash, including undervalued and less-recognized areas such as Emerging Markets Value, Europe, and U.S. Small Cap. While tech has experienced an impressive run, Research Affiliates’ compelling analysis suggests that conservative and safe investments might be a more intelligent choice in the coming years.