AAII Investor Update: Bonds’ 30-Year Run

Thursday, November 3, 2011
Charles Rotblut, CFA
AAII Journal Editor

AAII Resources

TIPS and the Nature of Inflation Protection
TIPS give protection against inflation rates, but are not without risks.

November AAII Journal
The new issue of the AAII Journal includes our 15th annual Best of the Net Guide.

AAII Discussion Boards
What asset class will perform best over the next five years?

Most Popular AAII Articles

  1. “How to Make Money From Bonds”
  2. “What to Watch in Your Portfolio”
  3. “Cash Kings”
“In 30-Year Race, Bonds Beat Stocks,” read a headline on Blooomberg.com earlier this week.

No, you did not read that wrong. Jim Bianco, president of Bianco Research, calculated an average annual gain of 11.8% for long-term bonds. Stocks lagged with an average gain of 10.8%. This has not happened since the Civil War, when the U.S. had a very different economy.

If you thought stocks, not bonds, were the best investment vehicles for beating long-term inflation, you’re right. This is still the case. The performance record of the past 30 years reflects two different events that combined to create a favorable environment for bond prices.

The first was interest rates. Ten-year treasury bonds yielded 15.8% on September 30, 1981, according to Bianco. Earlier today, the 10-year bond yielded 2.06%. Bond prices and interest rates are inversely related, meaning that as yields fell over the past three decades, bond prices rose.

The second was the stock market. Since 1998, the S&P 500 has experienced three severe market corrections and two nasty bear markets. These events hurt the long-term record for stocks, giving bonds an edge.

I would be remiss if I didn’t mention the Federal Reserve’s role in helping bonds. Alan Greenspan kept the interest rate environment favorable for the housing bubble. Ben Bernanke is intent on keeping long-term interest rates low for the foreseeable future, as he reiterated yesterday. Fed policy has helped, and continues to help, bonds.

At some point, Federal Reserve policy will have to change from trying to stimulate the economy to being more focused on controlling inflation. We don’t know when. We also don’t know to what extent interest rates, and thereby bond yields, will rise.

What history does tell us is that both stocks and bonds still play a role in your portfolio. Bond returns are uncorrelated with stock returns over the long term. This means that diversification benefits can still be realized by combining stocks and bonds. Inflation will be a threat, but then again, 30 years ago, the outlook for bonds was also uncertain.

What asset class do you think will perform the best in the future? Not over the next 30 years (that’s too long a period to forecast), but over the next five years? Tell us on the AAII.com Discussion Boards.

Worried About Inflation? Consider TIPS

If the threat of future inflation has you hesitant about bonds, TIPS may be an option. Treasury Inflation-Protected Securities are U.S. government bonds whose principal is adjusted by changes in the Consumer Price Index. These adjustments cause the amount of the interest payment to rise up or down with inflation.

Like any investment, TIPS are not without risk. Daniel W. Wallick and Jill Marshall of Vanguard explained both the pros and cons of investing in TIPS last December in the AAII Journal.

November AAII Journal Now Online

The November issue of the AAII Journal can be read on AAII.com. (Print copies are in the mail.)

This month’s issue features our 15th annual Best of the Net Guide. This guide lists the top financial and investment websites. Plus, as a new feature this year, Computerized Investing Editor Wayne Thorp highlights the best financial apps for iOS and Android.

The Week Ahead

Next Friday is Veteran’s Day. U.S. stock exchanges will operate on normal hours, but banks and the bond markets will be closed.

Approximately 20 members of the S&P 500 will report earnings. Included in this group are Dow components Cisco Systems (CSCO) on Wednesday and Walt Disney (DIS) on Thursday.

There isn’t much economic data scheduled for next week. September wholesale trade will be published on Wednesday, October import and export prices will be published on Thursday, and the preliminary University of Michigan consumer sentiment survey will be published on Friday.

No Federal Reserve officials are currently scheduled to speak.

AAII Sentiment Survey

Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 40.2%, down 2.8 points
  Neutral: 30.2%, down 1.8 points
  Bearish: 29.6%, up 4.6 points

Long-term averages:
  Bullish: 39%
  Neutral: 31%
  Bearish: 30%

Take the AAII Sentiment Survey »

Both optimism and pessimism about the short-term direction of stock prices were near their historical averages in this week’s AAII Sentiment Survey.

Bullish sentiment, expectations that stock prices will rise over the next six months, fell 2.8 percentage points to 40.2%. Even with the drop, this marks the third time in four weeks that bullish sentiment is above its historical average of 39%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, declined 1.8 percentage points to 30.2%. The historical average is 31%.

Bearish sentiment, expectations that stock prices will fall over the next six months, rebounded 4.6 percentage points to 29.6%. Even with the increase, pessimism stayed below its historical average of 30% for the second consecutive week.

This is the first time since July 2011 that we have had consecutive weeks of above-average bullish sentiment and below-average bearish sentiment. Though marking an improvement in attitudes toward the market, it is important to note that both readings are very close to their historical averages. The ongoing European debt crisis, slow domestic economic growth and frustration with Washington politics are all keeping individual investors cautious.

This week’s special question asked AAII members how the developments with European sovereign debt are affecting their sentiment toward stocks. The majority of respondents said that the situation in Europe was having a negative impact, that they were avoiding European stocks, or both. Several members expressed an aversion to foreign stocks, echoing comments made in last month’s AAII Asset Allocation Survey. A few members, however, said they were finding opportunities in emerging market securities.

Here is a sampling of the responses:

  • “European sovereign debt will incur more uncertainty and will negatively affect the U.S. and global markets, especially the European markets.”
  • “The problems are still not resolved in my opinion. So, I’m staying away from Europe.”
  • “I stay away from global stocks. I do invest in U.S. companies that have a global reach.”
  • “I am staying with what I currently own; I'm not taking new positions or adding to those already in the portfolio. The European Union has not dealt with Italy, Spain, Portugal or Ireland.”
  • “Scare stories from Europe are providing opportunities to invest in global stocks, which are cheap—especially emerging market stocks.”

Are you bullish, bearish or neutral? Take the AAII Sentiment Survey and tell us.

AAII Asset Allocation Survey

October Asset Allocation Survey results:
Stocks/Stock Funds:
 56.5%, down 1.3 points
Bonds/Bond Funds:
18.9%, down 0.4 points
 24.6%, up 1.8 points

Asset Allocation details:
  28.9%, up 0.7 points
Stock Funds:
 27.6%, down 2.0 points
  4.8%, up 0.7 points
Bond Funds:
  14.1%, down 1.1 points

See the survey »

Cash holdings reached their highest level since June 2010 as investors moved money out of stock and bond investments last month, according to the October AAII Asset Allocation Survey.

Stocks and stock funds comprised 56.5% of individual investors’ portfolios. Equity allocations declined 1.3 percentage points from September. October marked the third consecutive month that allocations to stocks and stock funds remained below their historical average of 60%.

Bond and bond fund holdings declined 0.4 percentage points to 18.9%, a three-month low. Even with the decrease, fixed-income allocations were above their historical average of 15% for the 29th consecutive month.

Cash holdings rose 1.8 percentage points to 24.6%, a 16-month high. The historical average is 25%.

AAII members participated in the survey throughout the month of October, so any impact the rebound in stock prices had on allocations may not be fully reflected in the results. This would particularly be the case for an investor who took the survey early in the month and then changed his allocations late in the month. Sentiment toward stocks improved throughout most of October, though it continues to register a high level of caution on the part of individual investors.

Perceived risks are playing a role. Yields for bonds are at historically low levels, and many individual investors are worried that interest rates will rise in the future. Sentiment toward stocks continues to be impacted by concerns about the pace of economic growth in the U.S., frustration with Washington D.C. and uncertainty surrounding the European sovereign debt crisis.

October’s special question asked AAII members if they recently changed their exposure to foreign securities (Europe, emerging markets, etc.). The overwhelming majority of members said they either didn't make any recent changes or left their allocations to foreign markets unchanged. Several respondents described their foreign holdings as long-term positions and said they were comfortable with their allocations. Others expressed concerns about the uncertainty in Europe and in China. A small number of respondents said they previously sold their foreign securities, while others either had recently bought or intended to buy foreign securities.

Here is a sampling of the responses.

  • “No change. I stopped investing in foreign funds about a year ago and primarily rely on U.S. blue chip stocks with a global presence.”
  • “I don’t have any foreign exposure beyond owning shares in global conglomerates that are based in the U.S.”
  • “No recent change. Foreign holdings are a relatively small portion of my portfolio and are concentrated in global and emerging market funds.”
  • “No change. I am maintaining a 25% equities exposure to foreign stocks because they will recover nicely after several years of underperformance.”
  • “The European situation and uncertainty about China make me want to stay away from foreign securities.”
  • “I see a buying opportunity in Europe. Quality assets are out of favor.”

Take the survey:

Wishing you prosperity,

Charles Rotblut, CFA
AAII Journal Editor