This Bloomberg story gets the headline right., but the lead (or lede) wrong. The intro “Buying 30-year Treasuries is returning more than stocks for the first time since Jimmy Carter was president. ” is wrong – bonds have beaten stocks in quite a few years since then.
The finding in the chart is much more dramatic, to the point that “earth-shattering” is justifiable hyperbole. What it shows is that, over the entire period since 1979, a strategy of buying 30-bonds (trading so that the portfolio always holds the most recently issued bond) has outperformed the strategy of buying stocks and reinvesting the dividends.
This is earth-shattering (or, at least, potentially finance-sector-shattering) because it refutes one of the central assumptions of nearly all investment advice: that, provided you are in for the long haul, stocks always beat bonds. Robert Shiller in Irrational Exuberance pointed out that this was historically true for the US (for periods over 20 years) but not for some other markets. Now it’s no longer true for the US.
Over longer periods, there is still a substantial equity premium; that is, the return to holding stocks exceeds that for bonds. But so there should be. Returns to stocks are much more variable than those to bonds, and, as the latest evidence shows, you can’t eliminate that variability by holding stocks for ten or twenty years.
The big puzzle is, why are stocks so volatile. They are more volatile than profits which, in turn, are much more volatile than aggregate consumption (unless the current stock markets are accurately forecasting a new Great Depression).
(via Brad DeLong )
John Quiggin 
Isn’t it the case that with the benefit of hind-sight one can always find two alternative strategies where one dominates another with respect to an ex-post specified criteria?
I am not impressed.
The literature on semi-strong form efficient markets falls into this category by showing, using past data, that ‘on average’ one could not make money on the basis of past and publicly available information. (The conclusion that therefore, the market is semi-strong form efficient is a jump to conclusion because the studies do not allow to distinguish between the set of publicly available information being ‘fully reflected’ or ‘not at all’ (Gross, 1996).
Usually only institutions and individuals who inherit non-trivial amounts of money at a relatively early age can hold 30 year Treasury bonds to maturity.
People who make money (or try to) in financial markets do so ‘successfully’ by moving in and out of segments of the market.
Watch what will happen to the Treasury bond yield when the cash rate is moving to 1%. The yield is important for people with a finite life and consumption that is dependent on the returns on financial securities.
Sorry, Professor, but it proves nothing of the sort. “In for the long haul” means you get to pick your selling point as you have sufficient liquidity to carry you through bad patches.
Obviously, if you chose to sell now you would make a lesser profit than if you had done a buy and hold strategy on US T-bills, but, as Ernestine correctly points out, that sort of strategy is limited to a very few. I would completely agre with Ernestine on this one.
Sorry, but this is one of the (few) instances where you are not only wrong, but clearly so.
It doesn’t surprise me that bonds would deliver better returns than stocks during an economic downturn. But the real issue is that the returns on bonds have to be paid for at someone else’s expense.
If governments go heavily into debt, then the debt plus interest will need to be repaid by future taxpayers.
There are a number of other issues related to government bonds.
One is that if governments throughout the developed world are going further into debt, will there be enough investors willing to invest in bonds to keep up with the escalating demand? Will interest rates have to rise?
In addition, once it becomes clear that governments are not going to be in a position to repay their debts in future how much longer will investors be willing to keep investing in government bonds?
When countries are unable to repay their debts they often resort to printing money. Methinks rapid inflation is on the way.
Concur MU
“If governments go heavily into debt, then the debt plus interest will need to be repaid by future taxpayers.”
That is why bonds are a bad long term investment. Governments use inflation to dilute away the value of the investors dollar so when it comes time to repay that dollar to the investor, it has a fraction of its original purchasing power.
Equities on the other hand do not have this problem. Earnings and dividends are generally in current dollars and so they are a better hedge for inflation.
Price is what you pay and value is what you get. The intrinsic value of a business is its future earning power. For some businesses not all, the price of future earnings power is heavily discounted at the moment.
Correction @1: Gross (1986)rather than 1996.
I guess that outperforms the Clitheroe style cliche we have all become so used to hearing in the financial adviser / fund manager drawl – “stocks beat everything else over time”
Tony G @5, you totally ignore the privately generated debt driven bubble in equity and in some physical asset markets.
Although the Bloomberg graph shows an equity index that is irrelevant for most small investors, it does show up nicely the growth in the bubbles since the beginning of the great leap forward back to the 19th century (Reagonomics, ….)[No typo regarding the century]. If we haven’t got the big one now then the next bubble is going to be even bigger, unless radical changes in the institutional environment (laws, regulations) are implemented soon.
Presumably in the long term returns on equity will improve from their current position. Overall though, I presume that at present this is not a bad thing. Governments need to borrow to stimulate their economies at present, so their bonds being more attractive than equity shoudl help achieve this.
#8 Could not agree more. It takes a dog more than one shake to dry itself.
On a complete diversion, off track, and totally irrelevant to this post – I see they have made a woman called Sue Morphet, the poster girl for corporate excess in salaries. At $1.8 million p.a. Sue hardly even rates… nice one boys at the Australian.
“Isn’t it the case that with the benefit of hind-sight one can always find two alternative strategies where one dominates another with respect to an ex-post specified criteria?”
Well, yes. The point of the post, which most commenters appear to have missed is that the strategies graphed are those that were typically chosen by advocates of “equities for the long haul” to make their case.
For this case to work, contra AR, it has to be true that, provided you hold equities for at least some minimum time (ten years was the common claim) you will be ahead no matter when you sell. The point of the graph is that this is not true for anyone who bought more than ten years ago and needs to realise their assets now.
#3 The data shows that bonds outperformed stocks over the entire period 1979-2009 (or any shorter period ending at the present). Unless you want to call the last 30 years a downturn, I think you misunderstood the post.
A number of commenters seem to hint at an expectation that stocks will, fairly soon, recover much of ground they have lost, so that investors who can ride out the current slump will be made whole. This can’t be right if any form of the efficient markets hypothesis (even weak form) holds. Weak form efficiency says that stock prices are a random walk, so the Dow doesn’t “remember” it was at 14000 a year ago. The best estimate of future price (based on stock prices alone) is the current price plus the long-term growth rate for stock prices.
Let’s suppose that the equity risk premium is at its historical level of 6 per cent and the real bond rate is 1. That means investors are expecting stocks to rise at about 7 per cent a year, so that the Dow should return to 14 000 (about where it was in 2000) by about 2019.
Ernestine;
What about this earnings bubble;
Overall Gain – 1964-2008…..362,319% pdf
He is not broke yet and I am pretty sure anybody who bought in with him in 1965 is glad they didn’t put their money into bonds at the time.
He buys bonds from time to time, but I think that would endorse what AR said @ 2.
P.S. for what its worth, (to him and his investors a lot) he doesn’t believe in EMT, but he loves making money from those that do .
#12, point taken. I actually had to rush out and pick up some groceries, so I only had a brief look at the article.
The only other thing I would reiterate is that the returns on bonds are only real or sustainable if one believes that governments are likely to be capable of generating the future surpluses needed to repay debt and interest. Given the future financial pressures governments will face, I don’t think that is a realistic assessment.
This gets back to my other point that if governments are unable to pay their debts or borrow more money, eventually the only option is to increase the money supply and thereby inflation destroys the return on bonds.
The point is that the notional returns on bonds cannot be real unless you have confidence in the ability of governments to repay. Otherwise they are merely promises put off into the never-never.
JQ notes “A number of commenters seem to hint at an expectation that stocks will, fairly soon, recover much of ground they have lost”
In this sort of market, and with so many losses still monumentally accummulating, Id be very wary of the dead cat bounce.
The 1929 crash had a pretty good dead cat bounce. Its ok if you can stalk and pounce like a cat.
Tony G says “That is why bonds are a bad long term investment. Governments use inflation to dilute away the value of the investors dollar so when it comes time to repay that dollar to the investor, it has a fraction of its original purchasing power.”
Tony, that is why if any individual or institution is to lend money to governments the sensible thing to do is to either lend the money in a foreign currency (thereby preventing an increase in money supply to repay the debt), or add an inflation adjustment to the terms of the bond.
Most investors currently financing bonds are getting neither of those two conditions.
Tony G
That is just anecdotal evidence. What about the many stocks that have been wiped out returning -100% to investors. It is no more fair to argue in favour of stocks by picking a single case than to judge the issue by running the analysis at isolated points in time that favour one class or the other.
Another point regarding the relative returns on stocks versus bonds is that the returns on bonds cannot be sustainable unless stocks recover.
If stocks remain weak, this must have an impact on government revenues (like capital gains tax, company tax). Moreover, a weak stock market is often indicative of broader economic weaknesses that would have to impact on government revenues like income tax.
In this situation, governments would certainly continue to run significant budget deficits. This raises the question of where will the money come from to repay the debts governments are currently running up?
It seems that for bonds to outperform stocks consistently over the long-term, the private sector economy would have to remain weak but at the same time governments would have to find some way of raising the revenues to fund expenditure plus service their debts.
I can’t see how this is sustainable.
Its that one shoulder of a head and shoulders or is it twin peaks I see in that world stocks line -either way its volatility is enough to put me off.
I am not really shocked by this at all. Exceptionally high volatility in equitites, combined with risk-aversion, has lead to the spike in bond prices. This is not earth-shattering.
Even with the argument that in the long-term equities outperform bonds. All that has happened is that we have extrapolated 30-years worth of data after an significant shock to the system has occurred. When the risk appetite comes back the equities will shoot up again.
MU is correct about the concern for inflation. My view is that we will see it hit in the recovery. But there are always investment strategies for the institutional investor to be protected from this.
On bonds and paying off the resulting deficits:
If a government is trying to appropriate resources beyond the country’s sustainable capacity to supply, fine, later inflation erodes the real value of the government debt. But if the deficits were used to fund WW2, it’s churlish to complain about the erosion of the debt.
What if it’s to help stop the Great Recession turning into the Great Depression? So long as there are idle resources, the debt can be met from the higher income resulting from reactivitating the economy. As income rises, the amount saved rises and so does the level of taxes harvested. Much of the deficits are self-funding in this particular case.
Sean G@21 says: “All that has happened is that we have extrapolated 30-years worth of data after an significant shock to the system has occurred.”
No. There wasn’t a “shock to the system” but an endogenous break-down.
Never before in the history of humanity has there been such additional risk taken on by the market – it is a shock to the system.
This is a shock to the system, the like of which we have not seen for over sixty years and this has fed the fear factor causing a flood into the bond market. I do not disagree that this type of creative destructionism is endogenous to the capitalist system but the nature of what we are experiencing is a shock to the system.
Tony G @14,
Your link refers to data for the
Berkshire’s Corporate Performance vs. the S&P 500.
The data shows that the point about the limitations of long-term performance data for finitely lived individuals holds even if a ‘waste not-want-not’ guy like Warren Buffet has a say.
There is no ‘bubble’ in this data. All it shows is that Buffet did better than those who trust in S&P selected companies.
Bruce,
The massive increase in government borrowing is not resulting in idle resources being used. All it is doing is funding poorly targeted stimulus packages. You are overestimating the multiplier effect of the stimulus package and assuming that the government has perfect knowledge of where the idle resources are in the economy.
Inflation will be looking to pick up after this crisis but what will happen is that institutional investors will demand more inflation-linked bonds by government and corporations. This reduces the dampening impact inflation has on the debt capital markets but will ultimately require strong and consistent anti-inflationary fiscal and monetary packages. This
Sean @ 21, good point.
If one is to compare the long-term average returns of bonds and stocks, it does seem somewhat selective to pick a point in time where stock values are unusually deflated as the end-point for the long-term comparison.
One of the obvious problems here is that in any economy the cost of raising finance cannot be consistently greater than the value of returns generated by other economic activity. If it was, no-one could afford to borrow money and service their debts.
For example, how could someone running a business afford to borrow money to expand their operations if the returns on their investments were not enough to even pay the interest?
So it is hard to see how investors lending money can sustainably expect higher returns than other forms of investment, when the ability to repay the debts and interest is ultimately dependent on the ability of the rest of the economy to generate economic returns sufficient to service those debts.
PrQ,
Can you link to anyone making this claim? The one where “provided you hold equities for at least some minimum time (ten years was the common claim) you will be ahead no matter when you sell”.
If so, I would submit they have a total ignorance of history. there have been several periods of time where this has not been the case.
@29 Jeremy Siegel in “Stocks for the Long Run” looked at the worst returns for stocks and bonds in the US for various periods from 1805-1998. This is measured in real terms (inflation adjusted).
10 years 20 years 30 years
Stocks -4.1% +1.0% +2.6%
Bonds -5.4% -3.1% -2.0%
Alot of people now are going to pull money out of the stock market and stop investing new money there. That means many would have bought when the market is high and sold when it is low. Not the best result.
Robert Shiller in the book that PQ referenced showed a strong (but obsviously not strict) correlation between low market PE levels and good 10 year returns. The PE levels are starting to get pretty low now. I would think that as long as you are investing for 20+ years, there would be few times as good as the present to invest.
Thanks for the Siegel cite, Paul, which answers AR’s question. For the US, a 30 year period (or even a 10 year period) in which bonds outperform stocks is indeed something new.
BarCap released some research (I haven’t got a hard copy) that measures +/- variance in equities and fixed income products over the short to long term. Equities tend to outperform bond returns over a 30-year time horizon.
So long as the current form of capitalism continues some will always have shares in others’ bonds.
I remember when the 2nd Iraq war was in the offing and the market was a bit sluggish. A bloke at work said, “I wish it would start so my shares will pick up.”
Apparently my response was bad form, “Oh, so you want people to die so you can make money?” It earned me frowns all round the meeting table before the formal meeting began.
33# Ikono – dont you hate that? You cant state the obvious. .. sometimes….without being silenced by sets of knitted eyebrows!
Your point? The guy was thinking – my retirement is being hit because of something thousands of miles away, my family are dependent on my future and it is being negatively affected.
What type of utopian vision do you have of the world?
My above comments were mean for Ikono
I’ll bet that Shiller was referencing PE ratios based on “actual” earnings. This is a problem for anyone trying to buy stocks based on this thinking as we don’t know what the “actual” earnings will be over the next 12 months or few years. We only have projected earnings, which during a recession are likely to be constantly downgraded. For example BHP is currently on a PE of about 11. Sounds like reasonable value. But who knows if their profits might halve over the next couple of years? In which case they are really on a PE of around 22. Even if they fall by 25% the PE is really about 15.
Historical research on buying companies when their PE is low is based on a historical record of actual earnings and hence actual PE ratios. But at any point in time PE ratios available to investors are just projections. Schillers work might have produced a different result if it was based on the projected PE ratios at the time an investor would actually have to make a decision, not the hindsight of what the earnings and PE’s actually turned out to be. Interesting questions that could be addressed would be how many companies that had good looking projected PE’s actually went bankrupt? These would not show up in his research as they never had subsequent earnings for them to be judged on. And how would an investor who based buying decisions on projected PE’s at the time have done? Even over the last year or two you could have lost half your portfolio buying companies with low PE’s that had subsequent earnings downgrades.
You can’t buy a stock with solid foreknowledge of what its PE will be, which makes quite a bit of the research around buying low PE’s invalid.
#33 34
Perhaps the politeness we hope for on this site should be extended to the workplace.
I think that frowns are justified when black humour by a co-worker is met by righteous naivete, as, by the sound of things, it was.
During one of the gulf wars, the demand for gas masks skyrocketed, and I chirpily remarked “It’s an ill wind…”. I was happy with grimaces and groans, responses that once were regarded as sufficient and appropriate — as well as sought. Nowadays I’d likely get a PC sermon from someone attributing views to me that I do not hold. Even in direct speech around a meeting table, layers of irony are missed by at least somebody.
#26 SeanG
Sure, models exaggerate. This is true of Keynesian models and classical models. But if the globe imparts fiscal stimulus, multipliers will be larger than usual (there are no global import leakages, of course). The national multipliers routinely trotted out are somewhat irrelevant.
Keynesians don’t need perfect knowledge about idle resources. Near enough is good enough. Though in a modern world this is trickier than in the 1930s. Back then, we could infer that the unemployed needed soup. Do todays unemployed “need” Foxtel? Back then, unemployed ship builders could switch from cargo ships to battle ships. Today, governments cannot really buy coal and iron ore to make up for the missing exports to China and Japan.
I have no problems with inflation-linked bonds (good idea, actually), esp. if they are based on demand inflation, and preferably not on supply shocks, oil prices etc.
No Way! DOW 36000 is around the corner. Just you wait.
[irony alert disabled]
Bonds may not hold up indefinitely, although I havent been checking the yield curve or volatility lately. A bond market bear would throw the comparison out a bit.
Just because equity markets have collapsed does not mean the last asset market devaluation. We have already also seen (USD valued) commodity, currency and property market crashes. Can security (ie bonds) be far behind?
What if US interest rates rise due to inflation or PRC unwillingness to take up or rollover bond issues? Then US T-bond values will fall, leaving investors cupboards totally bare. (Unless they have substantial hoards of gold or other collectibles.)
jquiggin Says: March 15th, 2009 at 6:05 am
Buffet is buying up stocks big time. But he is one of the few guys on earth who can defy Keyne’s maxim: “the market can stay irrational longer than you can stay solvent.”
Interesting chart from Motley Fool tracking US equity returns in 10 year periods since the turn of the 19thC.
10-Year Period (Dow Jones Average Return)
1998-2008 (9%)
1988-1998 (331%)
1978-1988 (165%)
1968-1978 (19%)
1958-1968 (77%)
1948-1958 (226%)
1938-1948 (14%)
1928-1938 (49%)
1918-1928 (254%)
1908-1918 (60%)
The past decade (1998-2008) where stocks were being swelled up by baby boomer superannuation-pension plans, cheap money by the FRB and extraordinary churn through computerised trading platforms has been the worst for one hundred years. Not to mention endless spruiking and touting by the “financial community”. Phrases like “Greater Fool” and “Even Break, Never Give a Sucker” come to mind.
Now any choice of base year or period span is somewhat arbitrary. Sure, measuring from peak to trough is unsound. Maybe there will be a spectacular recovery over the next decade.
The thing that sticks out is the explosive stock growth in the decade succeeding the US’s great world-historical military victories.
1919-1928: 254% – WWI
1948-1958: 226% – WWI
1988-1998: 331% – Cold War
I cant see the US repeating these kinds of sensational feats of power anytime soon, unless their sci-tecchies pull something out of the bag.
I think its time for a bit of history and a quote or two;
“Neo-classical or neo Keynesian economics, though providing unlimited opportunity for demanding refinement, has a decisive flaw. It offers no useful handle for grasping the economic problems that now beset modern society. And these problems are obtrusive – they will not lie down and die as a favour to our profession. No arrangements for the perpetuation of thought is secure if that thought does not make contact with the problems that it is presumed to solve.”
Nice to see someone else noticed the flaw, as long ago as 1972. Its a longer quote – too long for here.
JK Galbraith “Power and the Useful Economist” Presidential address delivered at the 85th meeting of the American Economic Association, 29th December, 1972 as cited in Wheelright E.L., “Capitalism, Socialism or Barbarism..”. preface.
According to Wheelright, “orthodox” economics suffers from the constricted methodology argument. The methodology used is too narrow to permit realistic results; behavioural assumptions too shaky; there is neglect of non economic factors and social situations, excess reliance on technique for its own sake and premature and excessive mathematisation, the role of power is ignored and the role of conflict downplayed.
Yet as Galbraith also notes
“A powerful tendency in modern political economy is for the voice of the affluent, and that of the business spokesperson in particular, to be mistaken for the voice of the masses… Unless economists understand that our subject is intrinically contentious – that what is good for the poorest of our people is best for economic performance – our economic policy will be a failure.”
On Australia’s future, Wheelright noted (1978) “In so far as market forces are allowed to dominate, Australia faces further integration into the world capitalist economy and disintegration of its own national economy and society. An additional twist in this direction will be provided by built in higher levels of unemployment, to which we are already being conditioned.”
Wheelright was correct. Those built in higher levels of unemployment have well and truly arrived. Underemployment and casualisation masks the lie that is unemployment. In all the discussion on Workchoices and the legislative changes in process – there is not one mention of the word “casual” or the great numbers of ordinary Australians now employed in this manner.
In terms of the collapse of the financial markets we have just witnessed, an interesting emphasis was made by Minsky and others (c.1970s) on liquidity problems – each time there is a crisis in a long run credit cycle, there is a substantial residue of debt left, so that a robust state of liquidity is never restored. The expansion and collapse of credit is used by the market to correct contradictions or imbalances such as under or overinvestment, yet also amplifies the long run economic cycles, so that any such “cure” (the aftershock of the credit collapse) may be worse than the original disease. Given an increasing residue of bad debt – this view would suggest each credit collapse will be worse than the one preceding it.
Ernestine Gross @ 25 and Socrates @ 18;
AR @ 2 said
““In for the long haul” means you get to pick your selling point”
My link to Buffets returns enforces what AR said. Buffet gets to pick when and what he buys and sells.
Timing is everything because it also means you get to pick your buying point.
This article “Buffet on the stock market” expands on the correlation between bonds and stocks and their interaction with interest rates over these bear and bull periods;
Page 2;
• Dow Jones Industrial Average
Dec. 31, 1964: 874.12
Dec. 31, 1981: 875.00;
&
?• Dow Industrials
Dec. 31, 1981: 875.00
Dec. 31, 1998: 9181.43
It also highlights why a simple buy and hold strategy for common stocks will not work. pdf
Alice re 43
In the 1970s you could support a family quite comfortably on one income. Now you need 2 incomes to support a family.
Tony G @45, Good for Buffet. My point is that if you were an investor in Berkshire Corporation, to which your original link referred, then you would have lost about 9.6% in value in 2008. During that time, you could have made a positive rate of return on bank deposits. (I am not stating a rate because I can’t be bothered looking up US data.)
The data you have provided suffers from the same limitation as that of other selective data sub-sets mentioned in this thread. Such selections are often done for promotional purposes or out of ignorance.
Tony #46
For once we agree on something although I suspect it was the post war years through 1960s to only very very early 1970s that that applied (you could support a family one oe income). I really dont think women entered the labour force in the 1970s in such large numbers because of “women’s liberation” or “freedom to choose.” I suspect the money needed to be put on the table.
Actually, I will correct that last comnment. It applied in the pre war years too. One income could support a family (yet in the great depression we aso saw women working more)…as I suggested in some other post – when the going got tough, women in history were more likely to enter the labour force or start businesses of their own – boarding houses etc yet even that seems too derogatory, there were many were ordinary and quite entrepreneurial businesses started by women in history).
Some called women and migrants “the reserve army labour force” (called in when needed and discarded when not needed) but this role, I fear has been shifted to the growing legions of casual workers (but then more likely to be dominated by women and migrants or aboriginies still ie those at the bottom of the labour force food chain) meaning, not white and / or not male.
Either way the equality of female income distribution in history behaved in the opposite way to the equality of male income distributions. Male equality declined in downturns, female income equality improved. More of us get hired, hence more participated in downturns – for whatever reasons – necessity? Cheaper substitute for male wages? Just for additional income for a family in bad times?.
But there is little leeway now as you suggest – it takes two incomes to pay an average city mortgage in good times or in bad. Who do you send to work to supplement the family incomes in downturns – there is no-one. They are already both working. The risk of debt or debt default is higher on the household in current times, exacerbating hardship when firms are shedding labour; exacerbating cummulative bad debts.
Alice – “Who do you send to work to supplement the family incomes in downturns – there is no-one.”
You send the children – there has been an enormous increase in child labour over the last 20 years. The service industries thrive on the labour of children.