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US bonds beat stocks over 30 years. This is a shocker for financial experts who insist that stocks always beat bonds over the long term
According to a recent research by Jim Bianco, president of Bianco Research in Chicago, from September 1981 till September 2011, long term government bonds of the US have gained 11.5% a year on an average compared to the S&P 500 index which has delivered 10.8% for the same period. This has come as a shocker to a popular belief, which is now almost an orthodoxy—stocks are obviously better than bonds over the long term. All over, every investing strategy is based on the assumption that stocks perform better than bonds over the long term. Taking on extra risk from stocks is expected to yield better returns.
To see just how rare the situation is look at what Jeremy Siegel, author of the book Stocks for the Long Run found out. The last time bonds posted their first 30-year gain was 150 years back in 1861, at the onset of the Civil War. In his book, he has compared returns of stock and bonds over 1,2,3,5,10,20,30 year holding periods from 1871 to 2006 and has concluded that stocks have outperformed bonds in majority of the periods. As the holding period increases, the probability that stocks will outperform fixed-income assets increases dramatically. Even calculated from major market peaks, the wealth accumulated in stocks is more than four times that in bonds where the holding period has been 30 years.
But if is it really not so, under what circumstances do bonds beat stocks? And can it happen in India as well?
The US rally in bonds has been fuelled by low inflation levels, slower economic growth and the Federal Banks’ decision to keep interest rates extremely low for a very long time, which is an unusual situation. Along with this, savings of the US households rose over the past several years. The US savings rate has tripled since 2005. The increased savings have not been channeled into stocks but safe assets like US Treasuries, leading to a higher return from Treasuries compared to stocks at least over the past 10 years. American households, under the fear of high unemployment and insecurity of the capital market, chose safer investment products such as bonds. According to data compiled by Bloomberg and the Washington-based Investment Company Institute, debt mutual funds have attracted $789 billion since 2008, compared with a $341 billion drop in equity funds.
Another new phenomenon over the last decade is, countries with large current account surpluses like China buying US Treasuries, pushing bond prices up further. More importantly, thanks to two major economic dislocations of 2001 and 2008, low interest rates have not fuelled a bull run in stocks as is normally expected. This is something that market experts were not at all expecting. An extended period of low interest rates always leads to higher stock prices.
Does this mean that bonds will perform better than stocks in future as well? Antti Ilmanen, in his book Expected Returns, warns that any sample period maybe biased, especially if the sample starts or ends at times of exceptionally high or low market valuations. The same can be said for the current sample, where bond yields were at an all-time high in September 1981, going above 15%, which itself was an exceptional situation. Ever since, it has been following a downward trend and is now trading at its lowest in more than half a century at around 2%. On the other hand, the US equity markets faced two major setbacks in 2001 and 2008.
Bonds Vs Stocks in other countries
Stock markets outperformed fixed income markets during the past century in all countries studied by Ilmanen. The compound average real return for global equities between 1900 and 2009 was 5.4%, which is 3.7% higher than that of long-term government bonds. Over 20-year or 30-year horizons, stocks have always beaten bonds. A few exceptions to it occurred outside the US in the 20th century and inside the US during the 19th century and the recent one.
The overwhelming evidence proves that bonds beating stocks could be a freak occurrence that will right itself, either by stocks going higher or bonds going lower. Indeed, after the hundreds of billions that the US Fed has pumped into the system, many experts feel that inflation, higher interest rates and a fall in bond prices are now looming possibilities.
As far as India is concerned, we are simply not comparable to the US in any respect. We don’t have an active government bond market, limited currency convertibility and therefore we do not attract foreign and retail savings easily. In that sense, bond prices would be less distorted due to a flood of money. Indeed, the biggest source of money into Indian financial markets—from foreign institutional investors—favours stocks. Indian stocks continue be attractive for what they are—vehicles for sharing increasing profits generated by the corporate sector. Indian bonds have outperformed equities only during 1996-2002 because bonds yields were high in 1996 and equities were low in 2002.
Italian PM Silvio Berlusconi has failed to issue growth measures demanded by the EU ahead of the Group-20 summit. Can Italy’s regime pass economic reforms which can restore investor confidence? Don’t bet on it
The acronym PIIGS (Portugal, Italy, Ireland, Greece, and Spain) seems to have a tinge of prophecy around it, finally. While you have Greece coming out of your ears now, and almost every writer or blogger predicting that Athens will spell the end of the euro-zone as we know it, Italy is now playing spoil-sport. Will Greece and Italy now deal a double-whammy to the great United Currency Concept of Europe?
Most economists are worrying themselves sick over the Greek economy and the referendum in Greece. There are even calls in Athens for a return to the drachma. Can the lira be far behind?
With all the brouhaha over Greece, there is less attention being paid to the state of the Italian economy. In Italy, investor confidence is already at a low, and the government is not willing to pass economic reforms aimed at restoring it. The Italian government is in as much a state of chaos as the Greek government. Government bonds in Italy are not yet trading at Greek levels. The only thing preventing the collapse in Italy so far has been the ECB (European Central Bank), whose monetising assistance has been contingent on Italy passing and enforcing austerity measures to deal with its runaway debt to GDP (Gross Domestic Product) of over 120%.
According to the Wall Street Journal, “Italian Prime Minister Silvio Berlusconi on Wednesday failed to issue growth-boosting measures demanded by European Union (EU) authorities ahead of the Group of 20 summit raising further doubts about the government's willingness to pass economic reforms aimed at restoring investor confidence in the country.” Berlusconi is now huddled with European heads of state, considering what have been called “shock-therapy” measures for the country.
It is not just the euro-zone countries or the G-20 which has voiced concerns. Italy’s economy might already be in a double-dip recession. BNP Paribas has cut its exposure to Italy by €8.30 billion. And the French-based giant bank has cut its exposure to Greece by €2.26 billion. Italy’s exports have also taken a hard knock.
And Germany continues to be the powerhouse. The only economy which is strong in the European Union is Germany. Greece and Italy are mired in trouble and the French are just about managing to make their ends meet.
Of course, with hindsight, one can say that the European monetary union was a harebrained idea. The union should have been preceded by a political union. Take China’s example. The mainland trades in the renminbi; but Hong Kong still has its dollar.
Berlin, of course, is not sitting pretty. German banks have huge exposure to the beleaguered European nation. And while ‘Great’ Britain stayed out of the monetary union, its economy is nothing to write home about.
So why does Europe have this habit of blowing up every 35 years or so? Of course, we are talking about both the World Wars and the current debt crisis. Only the first couple of times, Germany was crushed. Now Greece needs gifts; shoe-shaped Italy (might) get the boot... and Frau Merkel will remain untouched.