If the nominal interest rate on bonds becomes 10% and the historical average return of stocks in the US is 10% why would you ever invest in stocks?

Question

It seems like given the lower volatility of bonds and the prospect of equivalent return, bonds are the better deal. Am I missing something?

Answer 1

You are comparing the past with the expected future. Yes, historically stocks have averaged around 10% growth, but that is an average over a long period of time, and there is massive fluctuation around that. Gains(losses) have been anywhere between 40% and -30% in a year, with less variance as you look at longer periods.

But if bond yields go to 10% at any given time, that would put huge downward pressure on stock prices for various reasons. As stock prices go down, their expected return in the future goes up (you're "buying cheap"). Stocks will always have higher expected returns than bonds just due to their risky nature.

So it's still a tradeoff of risk/return - as you take more risk, you can expect higher returns on average. I don't think you'll ever find a time where you can expect 10% guaranteed return from bond and 10% return from risky equities. If you're satisfied with 10% safe return, that's fine, but you will likely see higher returns in equities, so there will be an opportunity cost.

Answer 2

10% is unusually high for bonds, and it's not likely to stay that high for long. Unless you include high risk "junk bonds".

10% on shares is more common if you combine growth and dividends. And if inflation remains high without the economy crashing, then shares might go up faster than that.

Answer 3

If interest rates drop, then borrowers will issue new bonds ASAP at the lower rate, in order to redeem the high-rate bonds.

Falling rates are also likely to stimulate growth, which means the stock market would grow.