If you are telling your clients that stocks always beat bonds over time, make sure that you are referring to time horizons in excess of 10 years. Data shows that long-term Treasury securities have actually outperformed the Standard & Poor’s 500 Index over the past 10 years. Morningstar Inc. data shows that while the SPDR S&P 500 ETF (SPY) has posted an average annual return of 7.27% per year, the iShares 20+ Year Treasury Bond (TLT) exchange-traded fund (ETF) has gained an average of nearly 9.3% per year during the same period.
A Historical Anomaly
It is not normal for bonds to outperform stocks over longer periods of time such as 10 years. Long-term bonds with Treasuries of at least 20 years have averaged a return of about 5.65% since 1926, while stocks have grown by an average of 10% in that time, assuming that all dividends and interest are reinvested. (For more, see: Overview of the TLT ETF.)
There are several key reasons why bonds and stocks have bucked the long-term historical trend during the past 10 years. Some of the major factors include:
- A low growth rate. The U.S. gross domestic product (GDP) has only grown at a measly 1.3% per year in the past 10 years. This is worse than any other 10-year period in history except for the Great Depression, when GDP grew by 1% per year from 1929 to 1939. This exceptionally slow growth rate has helped the performance of defensive instruments such as Treasury securities.
- A bear market. The bear market from 2007 through 2009 substantially lowered the overall returns of the markets from 2006 through 2016. In particular 2008 hit the average hard and the markets did not reach their previous highs again until 2015. Many market experts also now believe that we are in the late stages of our current bull market, which means that averages may get dragged down again in the near future.
- A bull market for bonds. In 2006, the 30-year bond yielded almost 5%. But rates have since plunged to 1.4%, which means that bond prices have risen during that time. The low interest rate environment has been a boon for bond prices, although this trend is likely to begin reversing in the near future. (For more, see: Advising FAs: Explaining Bonds to a Client.)
- Low government bond rates everywhere else. Although Treasury security yields are at historic lows, they are still better than what investors can get in the U.K., where a 10-year government note is paying about three-quarters of one percent and German 10-year notes are paying -0.18%. Meanwhile, the 10-year Treasury is yielding about 1.39%. This means that safe money is moving into Treasuries from around the world, thus driving up their prices.
It should be noted that intermediate-term Treasuries still lag the Standard & Poor’s 500. The iShares 7-10 Year Treasury Bond ETF (IEF) has posted an average annual return of 6.65% over the past 10 years, still behind the return of 7.27% posted by the index. And history also shows that bonds have beaten stocks in 14 different 10-year rolling periods since the Great Depression, usually during severe bear markets.
The Bottom Line
The recent outperformance of the Standard & Poor’s 500 by the long bond is still more of an anomaly than anything else. However, it does show the value of asset allocation, where a portfolio that holds long or intermediate-term bonds can provide competitive returns over time. But one key issue to consider at this point is the fact that both stock and bond valuations may be reaching their peak at this point, with a retracement coming in the months ahead. (For more, see: Government Bonds: Is 2016 the 'Year of the Bull?')