Bonds beat stocks

This Bloomberg story gets the headline (“Bonds beat stocks in earth-shattering reversal”) 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 and Paul Kedrosky)