A 20,000-Foot Perspective: Can Bonds and Equities Both be Right?

The combination of stagflation concerns from macro data and robust corporate earnings in the last week have helped bolster the case for a striking gap between fixed income and equity premia persisting, highlighting the complex and finely balanced growth outlook.

Every risk has attached to it a price, and from the 20,000-foot perspective of an asset allocator, financial markets often reflect distinct premia for any given risk or set of risks.

One of the more striking discrepancies in risk premia that has persisted since April Fools’ Day (April 1) this year is between fixed income (particularly government bonds) and equity markets. Where the former ‘bake in’ increasing caution, offering attractive compensation even after the recent rally, the latter appear to reflect growing optimism or even euphoria, with historically low premia (see chart).

Notably, these opposing moves have each garnered increased support in the last week or so: bond markets from ‘stagflation concerns’ captured in weak U.S. labor data, stickier inflation and tariff fears, and equities from remarkably strong earnings.

Can bonds and equities both be right? The short answer is yes—but typically only for discrete periods.

Comparing Apples With Oranges

A chief aspect of an asset allocator’s role is to set robust frameworks for assessing different markets against one another—or more colloquially, comparing apples with oranges.¹

Equities are quintessential long duration assets. So, for example, we can compare chain-linked forward global equity (MSCI ACWI) earnings yields with a bond heuristic comprised of long dated U.S. nominal or real yields with some spread risk thrown on top. Adding corporate spreads to duration bearing bond yields can be thought of as a ‘capital structure’ adjustment to make bonds more comparable to equities.

Importantly, equities are generally considered to be riskier than our bond heuristic, with more uncertain anticipated cash flows—and so while directional moves (or betas) can be similar, equity premia have tended to be higher than fixed income premia over time.

The Changing Relationship Between Bond and Equity Premia

Source: Macrobond and FactSet. Data as of August 6, 2025. Nothing herein constitutes a prediction or projection of future events or future market behavior. Historical trends do not imply, forecast or guarantee future results. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed or any historical results. Past performance is no guarantee of future results.

Breaking Through Equity Premia

Over time, including for most of the past 15 years, global equity premia have been pretty generous against both our nominal and real, or inflation adjusted, bond heuristic. But there have been three ‘breaks’ in recent history where fixed income premia have briefly pierced through equity premia, shown in the lower panel of our chart.

First, in 2015-16, when the U.S. energy crisis led to a significant widening in credit spreads reflecting a dramatic rise in default expectations that was not mirrored in equities given the outsized weight of shale producers in U.S. high yield indices.

Second, in 2020 during the depths of the pandemic, when average U.S. option-adjusted spreads soared to over 1000 points as credit markets effectively seized up and rose meaningfully ahead of equity earnings’ yields.

The third break has materialised since April Fools’ Day and has been unusual in three ways. Unlike the two previous episodes, higher fixed income premia are not being driven by credit spreads, which are actually near the tights, particularly in high yield. Rather, government bond yields (both real and nominal) have been the chief driver of wider premia, with longer dated yields in particular moving to reflect deepening caution over this period. Finally, and perhaps most importantly, equity premia have also been grinding lower this time, not higher as they were in 2015. They are also tightening from historically rich levels as optimism around future earnings, or cash flows, has grown. In other words, and unlike the past, both ‘legs’ of equity and bond risk premium have driven this most recent gap.

Looking Under the Hood

The equity risk premia (ERP)—which calibrates forward earnings with short term overnight interest rates—looks stretched across regions at present.

Through this simple lens, all major equity blocks, with the exception of Japanese equities, are at or through the lowest 20th percentile of history. The U.S. is most extreme, led by the largest 10 stocks (seven of which are the Magnificent 7), but the ERP in Europe, the U.K., Asia and emerging markets (EM) also look fairly full against their respective histories.

But even in the U.S., looking under the hood of the S&P 500, the ratio of cyclicals to defensive equities excluding commodities is consistent with meaningfully better growth outcomes than indicated by say 10-year U.S. bond yields, which it tracks closely. To be fair, this optimism has been fully justified by the ongoing earnings season, where earnings have handsomely beaten expectations in many parts of the world, with one of the highest ‘beat frequencies’ in a quarter of a century.

For instance, aggregate U.S. Q2 EPS growth is tracking at 9% year-on-year, more than double the 4% that was anticipated at the start of the season. European earnings at 4% represent an 8% beat thus far.

Meanwhile, looking more closely at bond curves, we detect continued traces of ‘macro scepticism’. Studying all active points on the U.S. government curve and their relationship with one another—which avoids ‘cherry picking’ any two particular maturities—we find that 42% of the U.S. sovereign curve remains inverted. While this is below the 70-80% typically associated with recession since the 1960s, it has failed to trace back to the 10% that we started with in 2025.

Active Multi-Asset Positioning

It is not clear when or how this gap between fixed income and equity premia will close; most likely, it will be driven by both lower bond yields and perhaps weaker equity returns in some parts of the world.

With a 6-18 month investment horizon in active multi-asset client portfolios, we have sought to capture both robust earnings and attractive fixed income yields in a highly targeted, or bar belled approach.

In equities, we have focused our risk in areas such as the U.S. Nasdaq, Japanese and Korean markets, where we have judged risks to be to the upside for the two chief drivers of returns—expected earnings and re-rating. We have balanced this with caution towards U.S. small caps, to capture concerns around a prospectively less friendly growth and inflation mix.

In corners of fixed income that perhaps over-compensate for this risk on the tactical investment horizon, we are long duration expressed via the belly of U.S. TIPS, or inflation-linked bonds, U.S. investment grade credit bonds and emerging market local bonds.

Attractive carry, potential rate cuts by the Federal Reserve, and solid credit fundamentals support both U.S. and EM duration—particularly intermediate durations with inflation protection in the U.S.—and selective high-quality credit. Being short the U.S. dollar, and commensurately long gold, also remain core positions in multi-asset portfolios.

¹Equities and bonds are relatively straightforward, in so far as the valuations for both assets are essentially driven by two primary and common factors. Namely: anticipated cash flows, composed of expected earnings and perhaps some dividends for equities, and coupons for bonds; and a (common) discount rate curve applied to these respective forward cashflows to allow us to bring forward future valuations to today.