Buffett: Why Own Bonds When You Can Own Equities?

 |  Includes: BND, BRK.A, BRK.B, TBT, TLH, TLT
by: The Rational Walk

Warren Buffett rarely makes major calls on the stock or bond markets or on the relative attractiveness of different asset classes. However, he has been making more comments on the economy over the past two years and made a remarkable statement yesterday at the Fortune Most Powerful Women Summit. Mr. Buffett believes that it is now “quite clear” that stocks are more attractive than bonds and “can’t imagine anybody having bonds in their portfolio when they can own equities”.

Here is an excerpt from Mr. Buffett’s comments:

It’s quite clear that stocks are cheaper than bonds. I can’t imagine anybody having bonds in their portfolio when they can own equities, a diversified group of equities. But people do because they, the lack of confidence. But that’s what makes for the attractive prices. If they had their confidence back, they wouldn’t be selling at these prices. And believe me, it will come back over time.

It is hard to imagine a stronger statement warning investors to stay away from fixed income investments, particularly long term bonds offering record low interest rates. A brief video clip appears below:

Dividend Paying Stocks

As we have pointed out in the past, high quality dividend paying stocks are currently trading at reasonable valuations and offering dividends that, as a group, result in higher levels of income compared to long term treasury bonds. In contrast to bonds, stock dividends have the potential of rising over time. While dividends are not guaranteed, there are many companies to choose from that have track records of stable or rising dividends that go back many decades. But as we have seen in recent years, the past does not guarantee future results. Few would have thought that General Electric’s (NYSE:GE) dividend was at risk, but it was cut severely during the recession. Therefore, diversification is essential for those attempting to build a durable flow of income from stocks as an alternative to fixed income investments.

Don’t Fight the Fed?

Why are ten year Treasury bonds yielding less than 2.4 percent this morning when government officials are directly stating that a new quantitative easing program is likely within the next month and there is a widespread desire for higher inflation? It is very unlikely that investors with a long term horizon are purchasing ten year bonds with a time horizon of a decade. Instead, there is speculative sentiment that government purchases of bonds (particularly those with maturities of five to ten years) will push up prices in the short run resulting in capital gains.

An aggressive quantitative easing program could very well result in ten year government bonds yielding under 2 percent and nice short term capital gains for those smart enough to exit positions before inflation rears its ugly head and causes yields to skyrocket at some indeterminate time in the future. This is the precise opposite of value investing and ultimately speculative in nature. Shorting treasuries is also a speculative exercise. Long term investors should listen to Mr. Buffett’s advice and avoid bonds that do not offer a reasonable prospect for positive real returns to maturity and instead consider the merits of reasonably valued dividend paying stocks as a source of more enduring income.

Disclosure: Long Berkshire Hathaway