The performance of U.S. equities has far surpassed the debt markets this year, and investors are hoping the trend will continue if recent shifts in asset allocations are any guide. But do stocks really have that much of an edge over bonds?
John Higgins, chief markets economist at Capital Economics doesn't seem to think so. According to him, the outperformance of U.S. equities over Treasurys won't be a lot higher in the next decade.
"Many [investors] expect the superior performance of equities to continue. While possible, we doubt it will be especially pronounced," Higgins said in a note on Tuesday.
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Capital Economics expects the average annual real return from U.S. equities to be only 0.9 percent in the next 10 years if the U.S. Federal Reserve meets its 2 percent inflation target, compared to a 0.8 percent gain from bonds in the same period.
That compares to returns of over 18 percent from U.S. equities so far this year, while returns from 7 and 10-year Treasurys are down 6 percent.
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The reason the predicted real return from equities is "barely" more than bonds is because cyclically adjusted price to earnings (P/E) ratios and earnings for listed companies are high compared to their long-run averages, Higgins said.
"If each (P/E and profit margins) were to revert to their mean, each would exert large drags on the total return," Higgins added.
Robert Aspin, head of equity investment strategy at Standard Chartered, however, said equities should continue to outperform bonds as the U.S. economy recovers and inflation rises.
"A 2 percent inflation target is fine for equities, basically equities should perform very nicely within a stable inflation rate," Aspin told CNBC. "The reason we are negative on bonds is the expectation that yields will continue to rise."
Aspin expects yields to rise on 10-year Treasurys by around 50 basis points over the next six months.
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Longer-dated Treasury yields including the benchmark 10-year notes hit next two-year highs of 2.9 percent on Monday as investors worried about market fallout should the Fed started tapering its bond purchases next month.
Ben Lichtenstein, president at Tradersaudio.com, agrees the selling in the bond markets has further to go.
"What the market is telling you is its seeking value at this point and where that value is, is really anyone's guess," Lichtenstein said. "This type of trade could continue a lot longer and sustain itself much longer and for a longer duration than you think is even possible."
StanChart's Aspin expects U.S. equities to rise another 8 to 10 percent in the next 12 months, while bond yields could hit around 3.5 percent or higher in the same period.
"As the economy strengthens and inflation starts to pick up, we would anticipate that equities would continue to outperform bonds going forward," Aspin added.
- By CNBC.com's Rajeshni Naidu-Ghelani. Follow her on Twitter @RajeshniNaidu
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