by Mike Moody
Frankly, I am amazed that investors have not been blasted by buying bonds at these yields by now. Retail investors typically get their timing wrong—and maybe it will still happen eventually—but for now they’ve been right to buy bonds. A recent article at Bloomberg discusses the magnitude of the reversal of fortune:
Long-term government bonds have gained 11.5 percent a year on average over the past three decades, beating the 10.8 percent increase in the S&P 500, said Jim Bianco, president of Bianco Research in Chicago.
The combination of a core U.S. inflation rate that has averaged 1.5 percent this year, the Federal Reserve’s decision to keep its target interest rate for overnight loans between banks near zero through 2013, slower economic growth and the highest savings rate since the global credit crisis have made bonds the best assets to own this year. Not only have bonds knocked stocks from their perch as the dominant long-term investment, their returns proved everyone from Bill Gross toMeredith Whitney and Nassim Nicholas Taleb wrong.
“The generation-long outperformance of bonds over stocks has been the biggest investment theme that everyone has just gotten plain wrong,” Bianco said in an Oct. 26 telephone interview. “It’s such an ingrained idea in everyone’s head that such low yields should be shunned in favor of stocks, that no one wants to disrupt the idea, never mind the fact that it has been off.”
Unlike Bill Gross, however, our global tactical accounts currently have a slug of bonds. This is why we use relative strength data rather than our personal opinions to invest. The fact is that bonds have been a relatively strong asset—their place in our portfolios was earned. No doubt that will change at some point going forward—and when the relative strength changes, we will too.
Here’s what is going to be interesting: how will the MPT / strategic asset allocation crowd react? If you run a pie chart at your firm, will it now suggest the bulk of the account be invested in fixed income? If the model is using mean variance optimization based on historical returns it should, since bonds have had both higher returns and lower standard deviation than equities for the last 30 years! Somehow, I doubt that is going to happen.
I’m betting that most firms will continue to emphasize stocks in their strategic allocations, by shifting their emphasis to “future expected returns” and suggesting that stocks will do better than bonds going forward from these price levels. There’s no way to know if that will happen, and it conveniently ignores the fact that they certainly did not anticipate that bonds would do better than stocks over the past 30 years based on future expected returns. Speaking just for myself, I can testify that every pie chart I have ever seen in my 25+ year career has always had a majority allocation to equities for a growth-oriented investor. There are some real questions about intellectual honesty embedded in those pie charts.
Mr. Bianco is right. No one wants to disrupt the idea that stocks should outperform bonds, never mind that it’s been wrong! To me, this is a fundamental reason why investment decisions should be driven by data and not opinions.