USAToday "Why are bonds outperforming stocks over long term?"

[web_diva]

Interesting article
Why are bonds outdoing stocks over long term?

Despite a reputation for being a slow-growing alternative to stocks for the risk-averse, bonds just passed stocks' long-term performance over the past 30 years.
The fact bonds have topped stocks over such a long period shakes up preconceived notions and further insults stock investors, who have endured historic volatility as they got lower returns.
"No one thought the tortoise could catch up, and it just did," says Ken Winans of Winans International.

 

[NW-Bound]

It was true only over the last 30 years. And the article also re-iterates other pundit opinions about how that bond run may end soon.

 

[ejw93]

Bonds have been on a roll over the last 30 years due to the steady drop in interest rates.

I remember circa 1980 when my parents had a mortgage just under 14% and thought it was a good deal.

Fast forward 30+ years, and my 30-yr mortgage is under 4%. A 10 percent drop in long-term rates!

I've still got bonds in my tax-deferred accts, but nothing with weighted maturity greater than 5 years.

 

[ziggy29]

Unless you believe that bonds can start yielding into the negatives, the math is running out. Over the last 30 years bond yields have gone between 2/3 and 3/4 of the way down to zero already. Even if there's room for a little more upside due to continued drops in bond yields, it's clearly limited at this point.

 

[GrayHare]

Until we can look back (later this year? this decade?), we won't know exactly when the musical bond chairs will end. Something that cannot continue forever won't, hence for 3 years I've been slowly DCAing out of bonds.

 

[NW-Bound]

Yet, I recently saw somewhere that people were still flocking into bonds, as measured by the recent cash inflows into bond funds vs. inflows into stock funds.

Wisdom of the crowd? Or is it folly of the crowd? Each of us must decide for himself.

 

[audreyh1]

I think part of the current flocking into bonds is boomers retiring. There is probably going to be more competition for yield than in the past, and this might help keep interest rates from going up as far and as fast as they have in the past.

 

[clifp]

I think running to bonds is a combination of several things. It is fear and mistrust of the stock market. I've had several people ranging from an NCO in his late 20s to a very active 76 year old woman say they wouldn't invest in the stock market because they thought the system. There is a lot of yielding chasing, as my good friends Amerprise adviser explained as she up his bond allocation" this fund has up 40% in the last few years, we should buy more", and finally people are understandably very risk adverse after recent events.

My cynicism about the investing savvy of the American public grow each year so I take the massive inflows into bond funds to be a very bearish signal.

 

[Gone4Good]

30 years ago treasury yields were 13-14% and BBB bonds were north of 16%. Not terribly surprising that bonds promising greater than historic equity returns actually delivered greater than historic equity returns.

Any guess on what kind of returns today's 2% market will deliver?

 

[harley]

I'm curious if the recent run into bonds is limited to short term, or if people are actually buying long term bonds. In my case I moved a large portion of my cash into a short term bond fund (VBIRX) to get a better return. That's a move into bonds, but certainly not a belief that the bond market isn't going to take a turn for the worse. I think the Fed will be able to hold rates down for a bit longer, but then it's going to end.

 

[Gone4Good]

Bond Math, Returns, and Mana From Heaven

Given the rally in bonds in 2011, it might not be surprising that the Ibbotson Associates SBBI bonds index, a broad bond measure, returned 28% last year, crushing the 2.1% return of the Standard & Poor's 500 including dividends. The bond index also topped stocks for the past 10 and 20 years.

One thing that is worth mentioning, and probably poorly understood, is the difference between capital gains in the bond market and other kinds of capital gains.

Bond gains driven by declining market interest rates are not Mana from Heaven. They are an advance on future coupon payments. The only way we can pocket those gains is to leave the bond market.

Consider a 5% 10-yr bond issued at par where the yield drops to 2% day one. The price of my bond increases from $100 to $127 . . . weeeeee! I've just made a 27% annual return on my 5% bond and feel terrific. But the bond only promised me a return of 5%. So what happens?

Fast forward to the end of year 1. I get paid a $5 coupon, but a strange thing happens to the price of my bond. Even though market interest rates haven't changed, the market value of my now 9 year bond has dropped ~$3 to $124. Next year, I get another $5 coupon but my bond price drops another ~$3. That keeps happening until maturity, where I get back my original $100 face amount with no premium. So did I actually have a gain on these bonds? Only if I got out of the bond market.

We can rejoice for the time being that our portfolios have been fattened by the lower interest rate fairy, but the truth is, if we continue to hold those bonds we'll eventually give back 100% those gains. We're only going to earn our stated yield, and not a penny more.

10-year Treasury yields have averaged nearly 9% over the past 30 years. Add another 100bp or more for corporates.

 

[rescueme]

Wisdom of the crowd? Or is it folly of the crowd? Each of us must decide for himself.

Well stated, IMHO...

 

[Midpack]

Anyone think now is the time to overweight or pile into bonds? Asset class rotation, and catching bonds at a great time. The article undoes itself in closing - the headline is a teaser, and the author knows it. Slow news day...

•Historic declines in interest rates and inflation. The continual movement down in interest rates and inflation the past 30 years has been a boon for bonds, which rise in price as interest rates fall, says Charles Crane of Douglass Winthrop Advisors.

It would be a mistake to assume that bonds' strong run over the 30 years is destined to repeat, says Mark Hebner of Index Funds Advisors. Bonds have had stock-beating periods before, but stocks, over the very long term, still have beaten bonds, he says.

Looming risks also threaten the bond market, Larkin says. Moves by central governments for the past few years to hold interest rates down will eventually end, he says. If inflation creeps up, that, too, could put an end to bonds' run, Crane says.

When bonds are beating stocks for this long, Larkin says, "the first thing it tells you is you're probably at the most expensive bond market in our lifetime."

 

[ziggy29]

My cynicism about the investing savvy of the American public grow each year so I take the massive inflows into bond funds to be a very bearish signal.

Guess I'm not the only one with a contrarian streak a mile wide...

 

[MooreBonds]

I'm curious if the recent run into bonds is limited to short term, or if people are actually buying long term bonds.

I actually loaded up the portfolio of my recently deceased grandmother into any CD with a coupon of 4% or more - frequently 20-30 year CDs. There were also many relatively new floating rate spread CDs, that paid out 4x the spread between the 2 yr and 10 yr or 30 yr treasury yield. The catch is that I wouldn't buy the CD unless it had the 'death put' feature, where the heirs could force a redemption of the CD at par upon the death of the owner.

I wouldn't suggest anyone delve heavily into the longer maturity issues, unless it's just 5%-10% of their portfolio, and unless it's a 'decent' coupon (which are much harder to find these days than 2-3 years ago).

 

[rescueme]

Guess I'm not the only one with a contrarian streak a [-]mile[/-] smile wide...

Corrected it 4 U ...

BTW, took my bond profits over the last 12-14 months. The remainder are going into storage until the next time they show acceptable growth that will allow further "harvesting"...

 

[audreyh1]

Another reason I think people are still piling into bonds is that category was the big winner last year. As soon as bonds have a flat or negative year (easy with such low interest payments) along with an OK equity year, IMO those same people will be dropping their bonds and rushing back to stocks. They are the lemmings!

But I still think retiring investors will keep chasing yield and overall keep bond rates from going up as far as they might otherwise.

Audrey

 

[audreyh1]

A puff piece, anyone think now is the time to overweight or pile into bonds? Asset class rotation, and catching bonds at a great time. Same as chasing sector rotation, a common mistake by novice traders.

No. In fact, I'm concerned enough that I am considering changing my plan to increase my bond% each year as I age.

I have been increasing my bond allocation (and reduce stock allocation) 1% each year. Now I am considering only increasing the bond allocation by 1/2% a year, at least until interest rates "normalize". For me "normalize" means that the 10-year Treasury return to it's 3.5% to 4.5% range where it spent much of the 2000s.

I am currently at 53% equities. I am very reluctant to go below 50% equities.

Audrey

 

[ejman]

No. In fact, I'm concerned enough that I am considering changing my plan to increase my bond% each year as I age.

I have been increasing my bond allocation (and reduce stock allocation) 1% each year. Now I am considering only increasing the bond allocation by 1/2% a year, at least until interest rates "normalize". For me "normalize" means that the 10-year Treasury return to it's 3.5% to 4.5% range where it spent much of the 2000s.

I am currently at 53% equities. I am very reluctant to go below 50% equities.

Audrey

Yes same plan here, as part of my "ageing" plan I was thinking of slowly dropping my equities allocation to the 40-50% band (currently 54.5%, I like to keep a wide 10% band because I don't like rebalancing too often) but after due consideration I'm thinking I'm going to keep it at the 50-60% range until interest rates "normalize" if ever... I guess Japan has been waiting for 20+ years for that "normalization".

 

[FIREd]

The fixed income portion of our portfolio is mostly invested is CDs and i-bonds. We cashed in our TIPS and munis in the second half of 2011, paid off the mortgage with parts of the proceeds, and invested the rest in equities. Only about 10% of our portfolio remains invested in bond funds.

I remember reading a Vanguard article showing that, between 1976 and 1983, the increasing interest income from a diversified rolling bond ladder or bond fund more than compensated for the capital losses when reinvested. Since our bond funds are locked in retirement accounts, we plan on reinvesting the dividends for the next 20+ years, so I think we'll do OK.

 

[traineeinvestor]

Right now I'm finding that I either have to go a long way out on the yield curve or compromise on credit quality to get a positive real return on fixed income investments. Unless I believe that interest rates will stay at these low levels for a very long time (which is what has happened in Japan and what some pundits are predicting given the impact of rising interest rates on government debt servicing costs), the only real reasons for holding fixed income would appear to be:

1. a place to park my 2-3 years of living expenses/buffer for when other investments are not performing well

2. a place to park money while waiting for other investment opportunities to present themselves

With many good quality companies offering dividend yields which are comparable to bond yields, as things stand today, I would expect equities to outerform bonds over the longer term.

 

[audreyh1]

Yes same plan here, as part of my "ageing" plan I was thinking of slowly dropping my equities allocation to the 40-50% band (currently 54.5%, I like to keep a wide 10% band because I don't like rebalancing too often) but after due consideration I'm thinking I'm going to keep it at the 50-60% range until interest rates "normalize" if ever... I guess Japan has been waiting for 20+ years for that "normalization".

Exactly - which is why I don't abandon my plan for increasing bonds with age, but rather am considering making it a 50/50 bet. This stuff is impossible to predict - best to hedge one's bets.

 

[Gone4Good]

I remember reading a Vanguard article showing that, between 1976 and 1983, the increasing interest income from a diversified rolling bond ladder or bond fund more than compensated for the capital losses when reinvested.

I think that's true (and can be generally seen in this comment). A big difference between the 70's and today is thatyour starting yield was 7% or more, versus just 2% today. That means a 100bp increase in rates in the 70's still left you with a 2% total return versus a 3% loss today.

Besides, with CD's yielding nearly as much as the Total Bond Market Index we can get most of the coupon with none (or little) of the risk.

 

[audreyh1]

Besides, with CD's yielding nearly as much as the Total Bond Market Index we can get most of the coupon with none (or little) of the risk.

You bring up a good point about comparing CDs with something like the Total Bond Market Index.
Total bond Market Index is yielding 2.05% with a 5.2 duration.
The best deal on 5 year CDs right now is 1.81% - that's pretty close.

But Total Bond Market Index is yielding quite a bit lower than other diversified bond funds in it's duration. Reason? It has a huge amount in US Treasuries because that represents the total bond market right now. And that is what is pulling the rate way down. Also, many would argue that US Treasuries are way overpriced with respect to the rest of the bond market.

Contrast to DODIX which is yielding 3.85% with a lower average duration (3.9 years). This is more typical of diversified intermediate bonds right now.

Morningstar recently had an interesting article about core bond funds decoupling from their benchmark since 2008. http://news.morningstar.com/articlenet/article.aspx?id=539744

Audrey

 

[Gone4Good]

But Total Bond Market Index is yielding quite a bit lower than other diversified bond funds in it's duration. Reason? It has a huge amount in US Treasuries because that represents the total bond market right now. And that is what is pulling the rate way down. Also, many would argue that US Treasuries are way overpriced with respect to the rest of the bond market.

Contrast to DODIX which is yielding 3.85% with a lower average duration (3.9 years). This is more typical of diversified intermediate bonds right now.

True. We can always increase yield by taking more credit risk. According to Morningstar, DODIX has an average rating of BBB. Whereas CDs are basically treasury equivalents.