Bonds are quietly outperforming stocks

Stock prices are near all-time highs, but the real place to be this year is the bond market.

To the surprise of many on Wall Street, the long-underestimated fixed-income market is quietly outperforming its equity counterpart.

Many investors expected bonds to struggle this year as economic growth picked up and the Federal Reserve throttled back its long-running stimulus campaign.

Instead, bonds have rallied strongly amid jitters over the still-wobbly economy, the extended run in stock prices and lingering geopolitical turmoil. A dearth of investment alternatives also has given bonds a boost.

The rally picked up steam Wednesday as bond yields fell sharply.

The yield on the 10-year Treasury note dropped to 2.54%, its lowest close since last October. Falling yields boost the value of older bonds with higher yields.

Several bond sectors — including Treasuries, municipals and high-yield — have easily outpaced stock indexes such as the Dow Jones industrial average and the Standard & Poor’s 500 index.

“Isn’t that the curveball of the year?” said Marilyn Cohen, president of Envision Capital Management, a Los Angeles bond investment firm. “It’s just very surprising.”

The fixed-income rally has been watched closely by scores of baby boomers and individual investors who rely heavily on bonds for steady income.

The S&P 10-year Treasury index and the S&P municipal bond index each are up 5.7% this year.

That compares with the 1.1% advance for the Dow and a 3% gain by the S&P 500.

All the numbers are total returns, which measure changes in principal value plus any interest or dividend income.

“This is a very strong year for fixed income in general,” said J.R. Rieger of S&P Dow Jones Indices, who compiled the data.

Muni bonds, which are popular among small investors, have rallied this year as worries have faded about Detroit-like fiscal problems infecting other cities.

Through Tuesday, the average California intermediate muni bond fund is up 3.9%, according to Morningstar Inc. The average stock fund is up 0.7%.

An unexpected drop in interest rates also has helped propel the bond rally.

The 10-year Treasury bond surged late last year, climbing from 1.63% in early May to a bit more than 3% on Dec. 31.

Many experts thought rates would move higher, figuring that the long-plodding economy would finally gain altitude this year.

And it was widely assumed that the tapering of the Fed’s economic stimulus program also would drive yields higher.

“It was almost universally seen that it would be a bear market for bonds,” said Kathy Jones, fixed-income strategist at the Schwab Center for Financial Research.

But yields fell sharply in January, in part because frigid weather on the East Coast slowed the economy.

Tapering has seemed to have a muted effect on the bond market.

Yields rose sharply a year ago when former Fed chief Ben S. Bernanke first signaled that the central bank would reduce its bond purchases. Yields fell when the actual tapering started in January.

Beyond that, Treasuries got a boost from foreign investors seeking an alternative to European government bonds. Yields are exceptionally low in Europe, which is enduring a drawn-out economic malaise.

Opinion is split about whether bonds can continue to beat stocks.

Share prices fell Wednesday, with the Dow declining 101.47 points, or 0.6%, to 16,613.97. The S&P 500 dropped 8.92 points, or 0.5%, to 1,888.53.

Still, many analysts say the stock market has held up well considering that the S&P surged 30% in 2013. The S&P is up 2.2% this year.

Economic improvement in the second half of the year — for which many on Wall Street still hold out hope — could boost share prices.

But others said persistent weakness in the employment market and the absence of inflationary pressure will contain bond yields.

“The labor market has remained impaired. Inflation has remained benign,” said Don Plotsky, head of product management at Western Asset Management in Pasadena.

“Absent any moves in those two indicators, there’s nothing to really push rates substantially higher,” he said.

walter.hamilton@latimes.com