Rules of Thumb and the Current Bond Market

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In a recent Bloomberg interview, famed investor Stanley Druckenmiller shared a rule of thumb that I've heard many times over the years: a good estimate for the 10-year treasury yield is nominal GDP growth (real GDP + inflation).  

I'm not here to tell you Stanley Druckenmiller doesn't know what he's talking about (he most definitely does). But I am here to remind you that rules of thumb, golden rules, estimates, projections, averages, and even cited statistics can be misleading and dangerous when taken out of context!

In the long term, that 10-year yield = GDP growth rule of thumb is about right. It makes sense for that yield to trade higher when inflation and growth are higher, but is it always right?

Nope. Not even close.

The green lines below show the average 10-year yield at each level of GDP growth. You can see why the rule of thumb exists – the average is within each range, and higher as GDP growth is higher…but look at that range of yields! When GDP has grown between 3% and 6%, for example, the 10-year has traded anywhere between ~1% and ~14%! In 1982, the 10-year yield was above 14%, and GDP grew around 4.8%. The rule of thumb was a bit off that year.

Most recently, from 6/30/23 to 6/30/24, nominal GDP was 5.7%. The 10-year yield on 6/30/24 was ~4.5%. It's not exactly spot on, but it's reasonably close.

Going forward, the Fed expects inflation to be 2.1% and real GDP growth to be 2.0% next year.

2.1% + 2.0% = 4.1%. The 10-year yield is currently 4.07%. Maybe the estimates will be right, and the rule of thumb will hold. But don't let the rule of thumb mask that growth could take off, or inflation could spike (hopefully not), or any number of things could happen that cause the 10-year yield to increase and cause the bond to have a worse return next year. On the flip side, don't let the rule of thumb make you forget that there could be a "hard landing", deflation, flight to safety, or any number of other things that could push the 10-year yield down and cause the bond to have an even higher return next year.

Rules of thumb are ABUNDANT in the financial planning industry. "100 minus your age", the "4% rule", "hold 6 months' emergency cash reserves", "buy the dip!", etc. These can be helpful sometimes but can also be misleading and cause people to overlook important risks and rewards. We at the Center for Financial Planning are here to help you consider all outcomes, weigh how the risks apply to YOU, and work with you to make informed decisions. Have you ever seen a rule of thumb and wondered if it applied to you? Give us a call!

Nicholas Boguth, CFA®, CFP® is a Senior Portfolio Manager and Associate Financial Planner at Center for Financial Planning, Inc.® He performs investment research and assists with the management of client portfolios.

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