You can count on stocks to beat bonds over the long haul. That, at least, is the common wisdom, and much of the time it has even been true.
But not over long stretches lately.
With the chaos in the stock market in recent months, some advantages for bonds might be expected. But the outperformance of bonds isn't just a short-term effect of the coronavirus downturn or of the economic conditions that preceded it in 2020.
Over the last 20 years – which counts as a very long time for me – investments in important kinds of bonds have outperformed the stock market. That includes long-term treasuries, long-term corporate bonds and high-yield (or junk) bonds. It is true even after the startling rally in the stock market since March 23rd.
But the remarkable performance of bonds – and of bond funds – isn’t cause for celebration, and it’s not a recipe for building wealth in the future. On the contrary, the reversal of the customary bond-stock performance is deeply troubling.
It is a sign of how unreliable many assumptions about financial markets actually are these days – of how risky the markets have become and of how difficult it is to invest sensibly for the future.
"Whatever level of risk you thought you were comfortable with nine or 12 months ago, I'd recommend that you ratchet it down lower," said Gary Brinson, a veteran asset manager and scholar, who did pioneering research in the 1980s and 1990s that pointed out the prime importance of asset allocation in investment returns.
Broad decisions about which asset classes to hold account overwhelmingly for a portfolio’s total performance, that research determined, and stocks and bonds are the main assets for most investors in financial markets. But neither stocks nor bonds have been behaving as expected – and this misbehaviour has been going on for a very long time.
The performance numbers are startling. To calculate them, I used a series of Bloomberg indices, which I compared with the total return of the S&P 500, including reinvested dividends, from the beginning of 2000 to April 29th. These results are reflected in mutual funds and exchange-traded funds that hold broad arrays of bonds.
Here are the annualised returns:
– The S&P 500: 5.4 per cent;
– Long US Treasury bonds (with a duration of at least 10 years): 8.3 per cent;
– Long investment-grade corporate bonds: 7.7 per cent;
– Junk bonds: 6.5 per cent;
– Broad investment-grade bond index (the Bloomberg Barclays US Aggregate Bond index): 5.2 per cent.
Even the worst-performing of those groups of bonds – those in the benchmark Bloomberg Barclays Aggregate index – returned nearly as much as the stock market, and the other bond indices trounced stocks.
Despite the hiccups in the bond market in March, which required the intervention of the Federal Reserve, bonds produced their gains with much less stress. On a risk-adjusted basis, in other words. bonds were far better performers than stocks over the last 20 years.
"Everyone is always talking about 'stocks for the long run,' about how you build wealth through stock," said David Rosenberg, who runs his own firm, Rosenberg Research, in Toronto. "The truth is, it's really been 'bonds for the long run'. A lot of money has been made in bonds, and it's not over," he said.
Don’t expect this run of bond outperformance to continue indefinitely, however. For one thing, it has been possible only because bond yields – and inflation in the overall economy – have generally been declining for the last 20 years.
Consider some bond basics. For bonds, prices and yields move in opposite directions, and at the beginning of 2000, the yields on both 10- and 30-year treasuries (US government bonds) were about 6.5 per cent. Today, the yield on 10-year treasuries has dropped to roughly 0.6 per cent; the 30-year yield is down to 1.3 per cent. These are both extraordinarily low levels, which is why bond returns have been unusually strong.
These rock-bottom yields are also why what’s happened in bonds shouldn’t be taken as good news, or as a phenomenon that investors can easily exploit in the future. Yields are as low as they are now because the economy is so terribly weak and has required the heroic intervention of the Fed and other central banks to keep it going.
That’s true now but, really, it has been the case, on and off, since 2008, during the great financial crisis.
Second, it’s not just that bonds have performed extremely well over the last 20 years. It is that the stock market has been gut-wrenching. Despite the longest bull market in modern history, which ended in March, investors in the stock market have had to endure three horrendous bear markets since the start of 2000.
The S&P 500 declined 49.2 per cent from March 24th, 2000 to October 9th, 2002, by 56.8 per cent from October 9th, 2007 to March 9th, 2009 and by 33.9 per cent in less than five weeks, from February 19th to March 23rd this year.
After floggings like those, it’s a marvel that stocks have performed as well as they have over 20 years.
The maths of market losses is ugly: When you lose 50 per cent of your money, it must double in value just to get back to where you started. Stock investors have had to do that twice in the last two decades – before the coronavirus downturn – while the bond market has been comparatively steady.
The import of all of this is not that investors should load up on either bonds or on stocks. It is to hedge your bets: No one knows what the next 20 years will look like for financial markets, or even the next few months.
Bonds are, in some ways, riskier now than they were 20 years ago. With yields so low, bonds as a broad asset class look richly valued.
Further yield declines – and price increases – are unlikely but not out of the question. Japanese and German bond yields are negative, and it could happen in the United States, signaling severe economic distress but producing further outsize profits for bond investors.
But it’s also possible, a bit further down the road, that years of fiscal and monetary stimulus will set off a bout of inflation, which would depress bond returns.
Stocks seem even less certain. Valuations are not spectacularly cheap, given the sharp decline in corporate earnings now underway. Further steep stock declines cannot be ruled out, and, as I’ve pointed out, dividends are likely to plummet further during this crisis.
Over the very long run, I still believe that stocks will outperform bonds, for the classic reasons: stocks, overall, are riskier than bonds and provide a share of the future earnings of corporations, which should ultimately rise. I continue to buy stocks steadily through my pension fund but I’m also buying bonds.
And I’m contemplating the advice of Brinson, which is to reduce the risk in my investments further as the coronavirus downturn continues.
He recommends shifting some holdings into “essentially cash” – money-market funds or short-duration bond funds. You won’t get rich doing that. But you will reduce your potential losses in this strange time, and that could be worth a great deal. – New York Times 2020