Bonds winning over stocks past 20 years

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Quark
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Bonds winning over stocks past 20 years

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This chart, a favourite of Albert Edwards of SocGen, shows the returns from equities (MSCI World, including dividends), long-dated government bonds (over 10-year maturity) and 3 months dollar cash since 1996. Bonds are still winning, even after the big recovery in equities since 2009.
http://www.economist.com/blogs/buttonwo ... g?fsrc=rss

Of course, if stocks always won, there'd be no good reason for an equity premium.
BogleMe
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Re: Bonds winning over stocks past 20 years

Post by BogleMe »

I've often wondered the threshold at which folks start giving up on stocks because the historical risk/return is unattractive. In other words, how many years of an average annualized return in the low single digits (or worse) would it take? Enough, I suppose, to where folks couldn't point to a long term return of 7 or 8% or whatever it is currently. Stocks will always have a higher expected return, but what if in some hypothetical future their 50 year annualized return is 3% and that of bonds is 3% or higher? I feel like they kind of have to do better than that or the entire corporate capital structure falls apart.
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Re: Bonds winning over stocks past 20 years

Post by nisiprius »

Although I'm a very conservative investor and no cheerleader for stocks, "Albert Edwards favorite chart" doesn't look quite right to me. For that matter, although 20 years is a nice round number, it isn't a very commonly used nice round number; we don't see frequent comparisons of "the last twenty years." In other words, there's no clear explanation of the choice of starting point, which to me is always a red flag. The article itself says "Some will complain that this is cherry-picking the starting point (although that is not true of the chart, which includes the dotcom boom)." Sorry, it still should be assumed that someone is cherry-picking the starting point unless they at least have the courtesy of stating a reason for the choice.

Even worse is "Buttonwood's" throwaway phrase "...a negative equity risk premium this century." That is intentionally putting the patina of the word "century" on a decade and a half! I am very embarrassed to tell you how badly my aging brain is functioning, but the first thought that ran through my head was "That's impossible, the data for Dimson and Marsh since 1900..." and then remembered when "this century." I'm tempted to say "At least I know what century to write on checks," but "checks" dates me even worse!

For another, the choices of particular kind of stock and particular kind of bond are just a bit "off." They're not unreasonable, but they're not what I invest in. Long-term bonds, although they are frequently cited, are riskier (and have more return) than the bond market as a whole, so while they are the kind most likely to outperform stocks on occasion, they are also the kind likely to have the worst underperformance over periods of time when they aren't outperforming stocks.

Basically, though, for whatever it's worth, and as the article notes... the "problem" from my point of view as a U.S. investor who is not an enthusiastic internationalist--is that as you can see, over the last twenty years, my bonds--that is to say the total U.S. bond market, Vanguard Total Bond, orange.--certainly did not outperform my stocks--that it to say the total U.S. stock market, Vanguard Total Stock, blue. (S&P 500 would have performed similarly).

What actually seems to have happened is that the last twenty years were a particularly bad time for non-U.S. stocks. (Vanguard Total International, green).

By the way, and I do not want to wave the Stars and Stripes and I don't think the next century will be the same as the last--but it is still a long-term historic fact that over the last 115 years, U.S. stocks returned an annualized 6.5% real, while the world ex-US returned 4.4%.

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Last edited by nisiprius on Thu Jan 14, 2016 7:20 am, edited 1 time in total.
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nisiprius
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Re: Bonds winning over stocks past 20 years

Post by nisiprius »

BogleMe wrote:I've often wondered the threshold at which folks start giving up on stocks because the historical risk/return is unattractive. In other words, how many years of an average annualized return in the low single digits (or worse) would it take? Enough, I suppose, to where folks couldn't point to a long term return of 7 or 8% or whatever it is currently. Stocks will always have a higher expected return, but what if in some hypothetical future their 50 year annualized return is 3% and that of bonds is 3% or higher? I feel like they kind of have to do better than that or the entire corporate capital structure falls apart.
This is exactly what happened during what I call the "'Death of Equities' era," 1966-1982, although stocks emphatically outperformed bonds during that era. However, they did not outperform inflation. A famous BusinessWeek story is often mocked as a ludicrously bad prediction; the title was "The Death of Equities." But the subtitle was "How Inflation is Destroying the Stock Market," and is well worth reading, here. Just as you say:
Younger investors, in particular, are avoiding stocks. Between 1970 and 1975, the number of investors declined in every age group but one: individuals 65 and older. While the number of investors under 65 dropped by about 25%, the number of investors over 65 jumped by more than 30%. Only the elderly who have not understood the changes in the nation's financial markets, or who are unable to adjust to them, are sticking with stocks.

Says Alan B. Coleman, dean of Southern Methodist University's business school: "We have entered a new financial age. The old rules no longer apply."

The one rule whose demise did the stock market in could be summed up thus: By buying stocks, investors could beat inflation. Stocks were a reasonable hedge when inflation was low. But they proved helpless against the awesome inflation of the past decade. "People no longer think of stocks as an inflation hedge, and based on experience, that's a reasonable conclusion for them to have reached," says Richard Cohn, an associate professor of finance at the University of Illinois.
So one answer is that in 1966-1982, people began giving up on stocks about 13 years in. Needless to say, even before the late 1990s, the performance of the stock market from 1982 though 1995 was a spectacular 16.4% average and then it just got better. Investors in the year 1982 had seen not quite twenty years of slightly lagging inflation; investors in 2000 had seen not quite twenty years of nothing but great, steady returns.
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Re: Bonds winning over stocks past 20 years

Post by nisiprius »

Actually the article raises a number of interesting points. And to my mind--I'm definitely grinding an axe here, folks--one of them is:
[that] equities always the best investment for the long run... is the message that is usually sold to individual investors... But there is an important caveat. Much of the data quoted by investment advisers is based on America, which is something of an outlier...
In other words, you can either be a cheerleader for stocks or you can be a enthusiastic internationalist, but you can't be both at the same time!

Another point--it's not a big deal and I'm not talking about a huge difference, but the "internationalists" seldom mention it--is that it is a plain fact that (for a U.S. investor) international stocks are somewhat riskier. Not hugely riskier, but somewhat. The prospectus says so. Vanguard puts Total [U.S.] Stock in risk category 4 and Total International in category 5. International investments have currency risk, an extra risk factor that's added on and doesn't add long-term return. According to Morningstar, the 15 year numbers are standard deviation of 18.26 for Total International and 15.39 for Total [U.S.] Stock, so a little more risk; Sharpe ratio 0.22 for Total International and 0.33 for Total Stock, so, not as good risk-adjusted return.

Throw in "Buttonwood's" suggestion that "stocks beat bonds" is less of a sure thing and may take longer to come true if you are talking globally, and this is what this means to me:

Rationally, given two investors A and B who are equal in all respects but internationalism, if A chooses to invest more of his stocks internationally than B, then A should be opting for a somewhat lower stock allocation overall. You ought to compensate for the extra risk of international stocks by investing less in stocks.

It's a small thing, smaller than the precision of knowing one's personal risk tolerance and smaller than the luck of the draw over specific periods of time. I don't want to pretend to do any precise calculation, but given that I believe the diversification benefit between U.S. and international is pretty small and generally overstated, a rough approximation would be, just doing linear math:

If you are 60/40 stocks/bonds U.S. and you decide to go total global for stocks, 30% of your portfolio now has a standard deviation of 18 rather than 15. So you should cut back to about 18/(average of 18 and 15) * 60% stocks, or 54/46.
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Re: Bonds winning over stocks past 20 years

Post by Quark »

nisiprius wrote:Although I'm a very conservative investor and no cheerleader for stocks, "Albert Edwards favorite chart" doesn't look quite right to me. For that matter, although 20 years is a nice round number, it isn't a very commonly used nice round number; we don't see frequent comparisons of "the last twenty years." In other words, there's no clear explanation of the choice of starting point, which to me is always a red flag. The article itself says "Some will complain that this is cherry-picking the starting point (although that is not true of the chart, which includes the dotcom boom)." Sorry, it still should be assumed that someone is cherry-picking the starting point unless they at least have the courtesy of stating a reason for the choice. ...
I read the article mainly as a refutation of the "stocks always beat bonds over the longish term" genre. It presents more evidence than just the chart.

Today is a logical ending point. Twenty years is a nice round number. Periods that are not nice round numbers and that don't start or end at something logical are more likely to be cherry picked.
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Re: Bonds winning over stocks past 20 years

Post by telemark »

I take it as an existence proof: it's possible, although not assured, for bonds to outperform stocks over what I consider a long period. Which seems like a good reason to own both, even in the current (cough cough) rising-rate environment.
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Re: Bonds winning over stocks past 20 years

Post by k66 »

Businessweek wrote:Younger investors, in particular, are avoiding stocks. Between 1970 and 1975, the number of investors declined in every age group but one: individuals 65 and older. While the number of investors under 65 dropped by about 25%, the number of investors over 65 jumped by more than 30%. Only the elderly who have not understood the changes in the nation's financial markets, or who are unable to adjust to them, are sticking with stocks.

Says Alan B. Coleman, dean of Southern Methodist University's business school: "We have entered a new financial age. The old rules no longer apply."

The one rule whose demise did the stock market in could be summed up thus: By buying stocks, investors could beat inflation. Stocks were a reasonable hedge when inflation was low. But they proved helpless against the awesome inflation of the past decade. "People no longer think of stocks as an inflation hedge, and based on experience, that's a reasonable conclusion for them to have reached," says Richard Cohn, an associate professor of finance at the University of Illinois.
(my underlining)

This has been making me think all morning. What was it that prompted the then-current 65-and-up age group to really keep their equities allocation (or even increase it at the time)? Was it, as the original author suggested, the fact that the seniors were too slow to grasp a new reality, or did they have better long-term insight as to market convulsions? Keep in mind, being 65 in 1979 would mean you were born in 1914 or earlier, had seen (or felt the effects of) at least one World War if not both, lived through the Depression, etc. Perhaps in their eyes, this was seen as just another "new normal" that would soon pass.

It's also coincidental that the morning FP led with this article: "No Normal is the New Normal...". Should we all now just capitulate all our traditional concepts and retirement planning just because a few "rules" appear to be broken, or can we still safely Stay the Course (regardless of how quaint and old-fashioned it may now apparently be)?!

edit to correctly reference "BusinessWeek" rather than "Newsweek"
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staybalanced
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Re: Bonds winning over stocks past 20 years

Post by staybalanced »

Also interesting that a simple black swan 30/70 small value and 10 yr treasury beat both with a lot less risk.
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Re: Bonds winning over stocks past 20 years

Post by Dude2 »

k66 wrote:This has been making me think all morning. What was it that prompted the then-current 65-and-up age group to really keep their equities allocation (or even increase it at the time)? Was it, as the original author suggested, the fact that the seniors were too slow to grasp a new reality, or did they have better long-term insight as to market convulsions? Keep in mind, being 65 in 1979 would mean you were born in 1914 or earlier, had seen (or felt the effects of) at least one World War if not both, lived through the Depression, etc. Perhaps in their eyes, this was seen as just another "new normal" that would soon pass.
I'm going to generalize here and probably draw wrathful comments, but my perception of that particular generation is this. People that "had money", i.e. affluent, were the ones that could invest in stocks. Recall it was nowhere near as easy as it is today to "get into the game". To invest in stocks meant that you had many other sources of wealth that allowed you to survive, versus living paycheck to paycheck. You were tapped into a subculture that knew about such things. A person that fits that description is going to be whole-heartedly caught up in the spirit of capitalism and the belief that stock investing was generally the right thing (what rich people did). Was this the middle class, i.e. average Joe's/Jane's? I don't believe so. Anyway, that's how I see those folks they describe. You will have to pry their stocks from their cold, dead hands.

Remember the huge percentage of the current baby-boom generation who have no retirement savings at all and gen-x'ers that are significantly behind? I don't think that greater access to the markets and open information changes that reality. People in general are not participating. Bravo for them to laugh at us who are so caught up in the panic. Who will be eating Alpo?
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