By Ian Salisbury

The stock market has been on a wild ride this year. Bonds, by contrast, have delivered solid, steady gains -- and may look like a better bet for the second half of 2025, too.

The iShares Core U.S. Aggregate Bond ETF, a popular exchange-traded fund that represents the broad bond market, has returned 3.4% so far in 2025, putting it on pace to deliver full-year returns of more than 7%. If that comes to pass, it would be the fund's best annual performance since 2020.

The S&P 500, for its part, is up just 2.1%. Most stock investors are counting themselves pleased, given the market's top-to-bottom drop of nearly 20% earlier this year. But the market still looks shaky, given that issues like historically rich valuations and political uncertainty haven't gone away.

"Most investors, still reeling from market volatility and the recent U.S. equity round trip, may be viewing resurgent momentum and index resilience as an invitation to add to the S&P 500. We would resist the urge," wrote Lisa Shalett, chief investment officer of Morgan Stanley Wealth Management, in a note Monday. "We see Treasuries and [investment grade] bonds as potential relative outperformers over the rest of 2025."

Lots of investors have soured on bonds recently -- it's no secret why. Inflation spikes following Covid prompted the Federal Reserve to sharply raise interest rates in 2022. Since bond prices move in the opposite direction to interest rates, the move caused sharp losses for bondholders. The iShares Core U.S. Aggregate Bond ETF posted a 13% loss in 2022.

Those worries haven't completely gone away. More recently, investors have fretted about runaway government spending if Republicans pass their proposed $4.5 trillion tax cut. And a prolonged conflict in the Middle East could lead to a spike in energy prices -- a potential inflation driver.

Still, the consumer price index rose just 2.3% in April from a year earlier, its lowest reading since 2021, and close to the Fed's 2% target. Wall Street traders see a more than 80% chance the Fed will cut rates by at least 0.5 percentage points by year end, according futures market data. They put the chances of a rate hike at essentially nil.

Bonds could also get a boost from some less obvious sources, according to Morgan Stanley's Shalett, such as deregulation enacted by Republicans in Washington. She points to looser capital requirements for banks, which could give them extra room to increase Treasury holdings, as well proposed legislation to promote stablecoins, which are cryptocurrencies backed by traditional assets, like U.S. dollars. Growth in stable coins, therefore, stimulates demand for Treasuries, she argues.

Bond investors should be aware: Some corners of the market are riskier than others. The iShares iBoxx $ Investment Grade Corporate Bond ETF has outperformed the broad bond market, returning 3.6% so far this year, and the iShares iBoxx $ High Yield Corporate Bond ETF has done even better, returning 4%.

Still, investors may not want to risk gambling on volatile junk bonds for just a little extra annual return. Junk bond spreads -- the yield premiums investors earn for betting on stock-like high-yield bonds -- are at one of their lowest levels in the past decade, according to data collected by the St. Louis Fed.

It suggests investors aren't being compensated much for the extra risk they are taking on betting on shaky companies whose fortunes are closely tied to the health of the broad economy. If you are willing to shoulder those kinds of risks, you might as well do it in the stock market.

Write to Ian Salisbury at ian.salisbury@barrons.com

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June 23, 2025 14:50 ET (18:50 GMT)

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