Had a post from “Davidson” yesterday regarding inflation and bond vs equity returns. It illicited several responses on twitter that many folks, contrary to the results of the post would rather own equities in an inflationary environment than bonds.
True, and not. It goes to degree. In a low inflationary environment, asset inflation favors equities at the expense of fixed income bonds. BUT, as the post yesterday demonstrated, in times of “hyper-inflation” ie: The 1970’s, inflation’s destructive effect systematically reduces equity values, making the fixed income bond and its guaranteed return of principle more valuable.
My fried on twitter @zippertheory provided the following statistics:
Of the he stated:
As you suspected stocks get crushed in hyper inflation due to P/E compression (as you know discount rate increases dramatically killing all terminal values). I can only presume that if CPI is above 7% commodities/Gold and anything that resembles a natural resource would flying.
I’ve as included a handy chart from the book Unexpected Returns by Easterling that better illustrates my aforementioned point.
The chart (click to enlarge):
So the evidence is pretty clear that 4% inflation seems to be the magic number at which a weighting from equities to bonds ought to take place in one portfolio. The question then remains to be answered, “what effect will the unprecedented monetary expansion have on inflation”?
If you believe it will cause hyper inflation, it it time to begin researching bonds. With corp. bonds currently yielding 7% to 9% for very safe companies, it does put pressure on the return you need from equities when you consider the additional risk.
Note: A bond/stock hybrid can be also accomplished with high dividend paying stocks, for instance, a stock yielding 4% need only appreciate 3% to 5% to equate to the bond yields. Just make sure the dividends are safe….we have had a score of cuts the last year although it would seem the worst of them has passed
Personally I find it hard to believe the actions taken recently leave us with the rather benign 2% long term inflation rate the Fed predicted yesterday. It doesn’t match up with history.
That being said, for me it looks like 2%+ which means down the road I am going to be looking at some bonds….
Disclosure (“none” means no position):
47 replies on “Inflation: Stocks vs Bonds, An Update to Previous Post”
why odn't you work in the investment business… money manager, hf, broker etc?
stay tuned…..
Talk is cheap. To work in the investment business you actually need to know what you're doing.
To say that hyperinflation favors bonds is totally delusional. It's pretty clear that Todd Sullivan basically doesn't know anything about macroeconomics.
The inflation scenario in general is questionable. Research what happened in Japan. The U.S. central government debt is still low by their standards: Japan's debt currently stands at 120% of GDP. No one would ever say that the yen is anything but rock solid.
With blogging, you can just write a bunch of bullshit a make a few nickels through "clicks". With being an investment manager, you actually have to be right.
Ben,
"To say that hyperinflation favors bonds is totally delusional"
of course the last time we had it is the 1970's…that is exactly what happened… but why quibble with historical fact…
Haha what? Are you joking?
First, the 1970s was not hyperinflation. Argentina was hyperinflation. The Weimar Republic was hyperinflation. See how bonds held up there.
Second, you think that bonds were a good asset in the 1970s? Do you know what happens to bond prices as interest rates rise? Do you know where interest rates were in the 1970s?
yeah…of course I was talking US as i am assuming 99% of my readers invest in the US, not argentina. in that vein the 70's qualifies for the US…easily
i know what happens to prices, if you sell, return of principle should you hold is what makes them outperform ala the 1970's
http://valueplays.blogspot.com/2009/07/inflation-stocks-or-bonds.html
of course the opposite is true, if you buy the bonds at the inflation height, as rates fall, bond price rise..
No, the 1970s was not hyperinflation. It was high inflation. The term "hyperinflation" has a definition, and you're not using it correctly.
Saying that "if you buy bonds at the inflation height" you will do well is changing the argument.
Just as Warren Buffett bought stocks at the market bottom in the 1970s, when you bring in market timing it's comparing apples to oranges. You can't generalize and then say timing matters.
Also, the chart that you've linked is also intellectually dishonest. The stock market crashed in 1973, so beginning with the date of 1972 is like using spring of 2007 as the start of your measuring stick.
Any type of paper is a horrible investment in times of accelerating inflation, hands down. If you don't know this fact, you have a lot more to learn about finance.
I used to occasionally post on here and I see nothing has changed since I stopped reading over a year ago.
This has to be the most horrible post I have ever seen. At a time when hyper-inflation is not only possible, but the most likely conclusion… the author recommends investing in BONDS?????????????
Why don't you just go throw your money away! Geeze… While your "Twitter Friend" correctly stated an investment in materials would fly… you completely ignored the fact that any idiot knows the only way to make money and OUT-PACE inflation in an hyper-inflationary environment is to invest in hard assets! You could invest in the stock of US Steel for example or you could simply invest in Gold.
What you are recommending is guaranteed to lose money by definition. As interest rates sky-rocket the price of bonds will nose-dive because if a person had waited the new bond issuances would have been issued at a much higher interest rate.
People – I manage a Fund and don't typically provide advice, but I feel it's my public service to anyone reading this horrible blog.
If you believe in hyper-inflation and want to invest… invest in commodities. Then… when you think hyper-inflation is ending… if you want to invest in bonds.. go ahead, you'll make a fortune because as the hyper-inflation goes away your bond prices will skyrocket. But never, never, never invest in bonds prior to a hyper-inflationary environment. The inflation will easily outpace the return of your bonds and your real return will actually be negative!
The author states "stay tuned" about getting into investment management. Wow… are you kidding me? The world doesn't only have bonds and stocks to invest in… you need to expand your knowledge.. of everything.. before thinking of getting into investment management because you, sir, are a huge fool.
Stop hurting people. Stop blogging.
People – just to be clear. Just think a moment.
If there is hyper-inflation and interest rates are over 10% and Todd is telling you to invest in bonds yielding 6% to 7% do the math.
You're losing 3% per year to inflation.
I still just can't believe this post. I mean, this is Investing 101. I sincerely hope I posted quick enough. This entire blog needs to be removed, I can't believe someone would be stupid enough to say this with a straight face and well enough to make people believe what they are saying.
ker/ben…
gonna have to wonder about your reading comprehention here…
in the very specific example i give, i use 4% inflation as a reason to buy 7%-9% bonds. thus the example you gave to "refute" me is baseless as it was based on no example i gave..
i specifically equated hyper-inflation to "US style, the 70's". since i doubt many of us are looking to buy equities in Zimbabwe, currently experiencing technical hyperinflation i thought it best to use an example that actually meant something to 99.9% of the readers.
neither of you have addressed the fact that if I am so wrong, why, in the last example of "very high" "hyper" or "wicked bad" inflation (you pick the term so we can stop playing semantics) bonds in fact did beat equities
see previous post linked to..
if you are going to try to attempt to tear apart a post, at least do it honestly and do not mix and match numbers from it to make a point..
Ker, you are full of shit, you do not manage a dime…
Ben. inflation peaked 80-82, it is a standard 10 year chart, what your. you want to pick the bottom of the stock market to do the analysis but that is not the point, the point is inflation,
oh FYI, the market actually hit its low in '74, not '73. I could easily go to 84 with the example but by then inflation AND RATES has fallen dramatically so the bond performance would be enhanced even more, making more of a case
Todd, this was honestly just a bad post, and it isn't correct.
In fact, I can hardly even understand what you're saying: buying 7%-9% bonds at 4% inflation? If that's the scenario, then yes, that is a very good yield on a secured investment.
If you're talking about the '70s, where inflation was at, say, 13% in the U.S. and nearly 25% in the U.K., then being locked into bonds going into that was a horrific investment.
Things are a little different today though. For instance, I recently saw a presentation by Goldman Sachs that shows both AAA/BBB credit spreads over Treasuries, and they're wider than during the Great Depression, basically approaching 800 basis points on BBBs. For AAA paper, the spread is like four times what it was during the Depression.
Therefore, other things really aren't equal right now, and I do not doubt that fortunes will be made in debt. High yield and leveraged loans, even more so, for savvy investors.
I will grant you that this part of the argument is correct, but I don't think it's really what you're trying to say. It seems that what you're saying is what Ker responded to: (1) you're predicting very high inflation, and then (2) bonds are the best asset class because of this.
Ker is exactly correct in what he wrote. Investing in debt ahead of an inflationary wave is absolutely devastating. In other words, owning 9% paper at 4% inflation is good; whereas owning 9% paper at 20% inflation is not good.
Furthermore, in a case of even higher inflation — or literal hyperinflation — there is no doubt that stocks would outperform bonds. If the currency is worthless then the paper contracts to deliver currency are worthless.
Yet, as Warren Buffett put it, "people will still buy Coke whether they're paying with dollar bills or shark's teeth".
As far as inflation's efect on bonds is concerned, Ben's right. A rise in inflation pushes nominal yields up so as to compensate for currency depreciation. When yields go up, bond prices go down.
I can see recommending certain classes of bonds because they're undervalued, but an increase in inflation is beside the point in that case. They're recovery plays. An increase in inflation would still whittle down the real yield, which is fixed. If it's the inflation that makes the recovery possible, then the recovery bond play is going to have its potential clipped.
Let me put it this way: if same-maturity Treasuries ever go back to 8%, what would happen to the price of an 8% corporate bond? Long-term Treasruies were at that yield as recently as the late '80s, whene the inflation rate was much less than it was in the early-mid and late '70s.
Anyways, Todd, no hard feelings on this end; I hope there's none on yours. I've found out the hard way (in a completely different field) that a direct-empiric approach sometimes ends up violating valid principles. It's one of the risks that an independent operator runs into.
"Oh Lord, you have to be humble
With boss-es always a-way."
Or:
"Be humble or be bossed." Another one I picked up through experience.
lol – Well – $3.5 million isn't a lot of money to manage… but we started with $1 million just like Pabrai. Down just under 5% from 1/1/08.
I find it amusing you're still trying to debate with people. You're flat out wrong. In a hyper-inflation environment the surest way to make money is to invest in commodities. Definitely not bonds. What is going through your head?
ker,
you still don't get it. the posts (both of them) was/were about as they said plainly "regarding inflation and bond vs equity returns"
that is it…
never was it said, "this is the best way to invest in inflationary times"
if you have read any more posts here would would have seen i have talked about buying oil "for inflation" countless times and was talking about DBC, the commodity index for the same reason
the problem here is you are arguing with me on a point i NEVER made…
hope you read SEC filings closer…
Dan, you are right, but inflation over 4% has historically had a greater negative effect on equities, making the bond w/ its coupon and premium return, the better investment of the two.
ben
"Furthermore, in a case of even higher inflation — or literal hyperinflation — there is no doubt that stocks would outperform bonds. If the currency is worthless then the paper contracts to deliver currency are worthless. "
they why didn't they in the 1970's?
Todd,
Because the 1970s was not hyperinflation. The dollar was not worthless in the 1970s. In hyperinflation, it essentially means that the currency is destroyed, like Confederate paper during the Civil War.
What is a bond? An advance of currency, by contracted terms. For instance, you contract to advance x dollars and receive 106%x dollars in return. But if the dollars themselves turn into Monopoly money, then the claim on those dollars — the bond contract itself — also becomes worthless.
Commodities and real estate will maintain value during high inflation or hyperinflation. But they may not earn a real return. Commodities and real estate ultimately move by the laws of supply and demand.
The reason that crude oil or lead or cocoa is a good investment is not only because they are inflation protected, but also because they are supply constrained. There is a fine point here, and it is possible to lose a serious amount of purchasing power in commodities and real estate even during an inflationary cycle.
Over time, though, the results are clear: equities are far and away the best asset class. Gold only matches the CPI, and bonds give you a pittance. I would urge you to look into Jeremy Siegel's work on this topic. Here is an instructive chart (note the distinction between millions and thousands):
http://gyst-ink.com/blog/wp-content/uploads/2008/08/simoney7.gif
Yes, there might be incredibly brief windows of time where bonds outpace sluggish equity returns. And you can slice and dice years and numbers to get the answers you want, as you have done with your chart.
But I wouldn't bet on that. The other guys are right: you are trying to argue a convoluted point that you're simply wrong about. Read Buffett's "Buy American" article. He doesn't recommend corporate bonds; he recommends equities.
Why are you correct and Buffett wrong?
ben,
i think you are being purposely obtuse..
seigel.. if we are using the buffett/munger duo as a guide, munger has called seigal "a loon" and dismissed all his work…
did not say buffett was wrong, nor I was right….
just did a simple explantion of bond vs equity returns in a high inflation environment… bonds won
As I told KER, i agree commodities are a great inflation hedge which is where i have advocated buying them here many times for that very reason, that was not the point of this particular post though….
until anyone can explain why in the 70's bonds outperformed equities means my saying in high inflation era bonds are the better bet than equities (not the best, just better than equities) is wrong, lets move on
Ben/Ker…
this is the argument we are having.
I am talking to someone in a bar & discussing why the the Patriots are a better football team than the hapless KC Chief's. You are both in the background telling me i am wrong & Pittsburg is the best cause they one the SB.
No shit, but that was not the discussion…
lol – fine, if that is your argument it is poorly expressed to an average reader.
None the less. Why not show average bond returns over the same period? As your table shows, in each inflationary environment the S&P had a positive gain (albeit perhaps not a positive real return).
How can you consider an investment in bonds without considering the value behind the bonds? You have no chart to show the change in bond prices nor the average coupon bonds were offering over the same time horizon.
Your argument is that the S&P return was not greater than the rate of inflation; therefore, bonds must be better. You have no evidence showing what the average coupon or the average decline in bond pricing was over the same period.
You state that sure, the bond price will fall, but you'll hold to maturity. Well, what maturity do you choose? If you wait too long, you're stuck holding bonds that you can't sell while stocks skyrocket. I think if you looked at the return of the S&P once it was evident the inflationary environment was ending, you would note that equities far outperformed bonds even as interest rates fell and bonds became worth more.
So, there you have it. You'll be locked into your bonds that you bought 1 or 2 years prior to the hyperinflationary environment without any opportunity of selling them because the capital loss would outpace the return you made on the coupon. You would have been better off holding onto equities that, at worst, according to your chart, have posted a small gain.
Ker,
again, look to the chart in the previous post..
it takes into account both long term and intermediate term corp. bonds vs equities
your argument fails because you assume bonds were bought at low inflation and held as rates rose.
the opposite would be true also over the 10 yr period bonds bought at the peak (or at higher rates) during that span would have seen prices increase.
the hold to maturity is used because it takes to most moderate reasoning. of course we could assume those who saw prices rise would have sold for more than principle, correct? by taking out the differences and using hold to maturity, we can get a truer return for the example
the diff. here is that equities prices practically flatlined over the period meaning, bonds and the coupon plus principle return were the better of the two investments
Also – don't forget that you've already biased the bonds by stating you'd invest in Corporate bonds. If you're going to use that bias, why wouldn't a person buy a commodity ETF and buy equities?
If you are making it a question of bonds vs equities – you must use all classes for each. Not recommend corporates over equities.
What does it take into account in regard to the income tax on the coupon payments?
And… as stated earlier, you're still biasing equities against corporate bonds. Since when did Corporate bonds equal bond investments and the S&P 500 = equity investments?
Bonds did not outperform equities.
It's still to be seen whether or not Corporate's outperformed the S&P 500, especially once you take into account taxes. I now also see Ben's rational and basis for argument with your chart and the start and end dates.
Based on what you have presented, it's obvious not enough research has been conducted to make any sort of assumption or investment based upon your data. This would not fly in the investment world and if you were an analyst you'd be thrown out the door. No way a portfolio manager would make a decision between bonds and equities using what you have presented… so again…… why are you presenting it to people who are likely individual investors that don't know any better and think you should be managing money b/c what you say sounds intelligent?
Todd,
Ker has it exactly right: you're not bringing much (if any) academic rigor to your data and supporting argument. You hand-wavingly dismiss Jeremy Siegel's research, an extremely distinguished professor at the Wharton School. That's pretty arrogant.
What you're saying does sound like something that would be argued in a bar, over a football game and Budweisers, not a conversation that would be had among money managers or economists.
The date bias, as Ker just said, makes your data flat-out bogus. You take the top of the stock market, 1972, and compare it with a major bottom of the stock market, 1982 (or the bottom in real terms). This is a joke. Such "data" says absolutely nothing.
Imagine if I said, "take 1990 to 2000, and look at how great stocks perform!" It's a completely biased sample. Adjust the dates to 1992 to 2002 and you get a different result. Then 1986 to 1996, a different result. Then 1998 to 2008, a different result. And either way, you're dealing with a bubble that was basically an anomaly, so what general result does that "prove"?
In other words, you can arbitrarily pick years and get the answer that you want to see. That's what you've done. Push the dates you use a few years forward or a few years backward, and you'll get an entirely different result.
And, as Ker says, it's not even clear whether the raw data itself is valid, as you provide no sources or details on how you procured it.
What you've done is nothing more than a ridiculously shoddy job at "research". As Ker says, if you did have a job on Wall Street, you would get a pink slip in response to this presentation.
pointless…
to go to 1982 was done because in 83, inflation rates fell 50% the "high inflation" period was over….we went back 10 years from there.
in 1972 inflation was 3.37%, the lowest of that decade. doing it this way got bonds off to a bad start in the example..
take another 10 years 1980-90
you bought corp bonds 12-15% (80-82) (inflation ran 10-14%). when dramatically rates fell 3-4 years later to 8% you got 20%+ YTM
the S&P over than decade returned 12%
buying bonds in a high inflation/high interest rate environment will beat equities
if you think my data is flawed, feel free to run it yourself and present the conclusion.
Wow, unbelievable.
You're missing the point that the data is already in: get an Investing 101 book or "A Random Walk Down Wall Street" or "Stocks for the Long Run" and see the results of bonds. Read the investment literature and economic theory.
These are extremely basic facts. But saying that "buying bonds through an increasing inflation and increasing interest rate environment will beat equities" — that's absolutely incredible. Personal finance really should be taught in our nation's high schools, because there is very clearly a huge problem.
You're obviously a hard-headed guy who can't engage intellectually in a discussion about basic principles of finance, and you can't accept that you're wrong. Let me clue you in: the reason everybody is criticizing this post is not because it's an ingenious piece of research.
I would forget about a money management career. Looking into something like construction or auto dealing is a better bet, to fit your personality and wiring.
Look, I will give you credit that your articles that dig through SEC statements are good and can deliver a service, but these ones on "research" and "tips" really damage your credibility.
Saying you're going to trounce stocks by investing in bonds is like when you said you earned 46% annualized over nearly a decade from Phillip Morris stock.
You're way outside your circle of competence here, and your calculations are wrong.
ben….
But saying that "buying bonds through an increasing inflation and increasing interest rate environment will beat equities"
i never said that, are you reduced to making things up now? that borders on a blatant lie…
i said "buying bonds in a high inflation/high interest rate environment will beat equities" …. NOT INCREASING…
when that high inflation & high interest rates fall, bond returns whip equities…just look at 1980-1990 for proof..
i am hard headed, when i see something happen, and then am told it did not, i have a hard time with that
if the information is so readily available, please present it. i have no vested interest in bond sales. if i am wrong and there is a way to better the experience for my readers, please enlighten us. i have done that hear before with folk who disagree with me, i think it betters the blog personally
my guess is that all we will get is another half true comeback and no real information…
the stage is yours if you want it…..
Seriously, why don't you work in the investment field. Your effectively a blogger who makes money off advertising..thats it. why not be compensated literally for your investing.
Todd is wrong in the grand scheme of things: bonds are very poor investments if inflation is high.
However, there are scenarios where that may not be true. Todd is correct on this. Assuming the original chart that was plotted in the prior post is correct, you can clearly see that bonds, at least corporates, beat the S&P 500 (I'm not sure if htis is the price index only or if S&P 500 includes dividends).
People blindly argue that bonds must necessarily underperform stocks during high inflation are either efficient market theorists who do not believe in unusual environments, or haven't really looked at history.
I can see bonds outperforming stocks even if inflation were high under two scenarios.
The first scenario is if bonds were undervalued (i.e. bond yields high). Even if inflation stays high and bonds are discounted more, high bond yields may make up for it. Most stocks will get crushed with high inflation while most the bond will still yield high returns in nominal terms (and possibly even a small positive real return).
The other scenario is if stocks were overvalued. This was probably the case in the late 60's and early 70's. Stocks were overvalued so bonds could beat stocks even if inflation was high. Bonds will get marked down but stocks will fall even more.
I'm in the mild-deflation/low-inflation camp so I don't think the US markets are a good test of what may happen. But, consider hte following: Brazil.
Brazilian short-term rates are around 8% and the long-term 8 yr government bond yield is around 12% right now.
I haven't checked the numbers recently but P/E (trailing) on Brazilian stocks is around 13, which is an earnings yield of around 8% (let's ignore questions over whether the earnings are depressed, or whether stocks are overvalued, Brazilian govt credit risk, etc).
Inflation is already high in Brazil (4%+) but let's say we get high inflation of around 8%. People arguing against Todd may not realize it but it's actually possible for Brazilian govt bonds to outperform stocks. The stock market can easily drop 30% to 50% if inflation doubled to 8%. You may actually end up with negative or very close to zero return on stocks for 10 years. But it's possible to end up with positive return on bonds (in this case, it would even be a positive real return of 2%.)
To sum up, I think Todd is wrong to generalize his view. Bonds are indeed very poor assets if inflation were high. However, unless you believed everything was rational and perfect, it's possible that a historically poor asset may actually outperform. How many people would have been shocked if someone said, a few years ago, that bonds will outperform stocks for the last 40 years? Or that gold will outperform stocks for 40 years? Yet, that's exactly what happened.
Alex,
there are some big changes coming to the blog in the next 2 weeks…
more stuff later in the year…
the ad $$ is irrelevant….ice cream $$/new hockey skates/sticks for the kids. the blogging process make one a far better investor IMO.
also has opened more than a few doors..
Sivaram,
That is a criticism i can live with…..
nothing is "always" or "never", one must look at the situation…
Wow, you guys are so far wrong that it's amazing. Here's an Investing 101 article from Investopedia:
http://www.investopedia.com/articles/basics/08/stocks-bonds-performance.asp
And Todd, you're putting words into my mouth; I did not say whatever it is that you're trying to convey there.
You present a chart showing the 1972 to 1982 period — a time of increasing inflation and interest rates, and a plunging stock market — and say that bonds are superior to stocks. This assumes that you bought bonds in 1972. And now you're saying that you've got to time the market for when inflation and rates decline — as if this could have been predicted — as they did throughout the 1980s. So are we talking about the 1970s or the 1980s? Are we talking about buy-and-hold or market timing? What are you even trying to say?
To end the argument, here is John Bogle on the topic:
http://moneywatch.bnet.com/investing/article/jack-bogle-why-stocks-will-beat-bonds-and-investors-will-miss-out/309685/
"Past returns are not a guide to the future. Start with that. Here’s what is a guide to the future (and I’ve written about this going back to my senior thesis at Princeton): Investment return is the dividend yield when you buy in plus earnings growth. But dividend yields can be cut, and they were cut by 22 percent this year, which is alarming. So that takes your dividend yield down to about 3.5 percent. And then you try to puzzle out what earnings growth will be. From these levels, I think it could pretty easily be 5 percent a year over the next 10 years. If we have a slower economy, it could be 4 or 3, but let’s say 5 percent. So let’s call the investment return 8.5 percent on stocks, compared to 6 percent on corporate bonds, and only 4 percent on treasury bonds. That would make stocks more attractive than bonds over the next decade."
So you're going to disagree with Ivy League professors, disagree with Buffett, disagree with Bogle — all the greats, with credibility in spades. I second what Kerbouchard wrote above: this blog needs to be shut down and Todd Sullivan needs to seek out further education, not — of all things — a money management career.
LOL!!
Ben,
read your own comment… it was a direct cut and past of what you wrote..
Bogle- who said i disagree with him? i own no bonds now. all my post have said "if we get the high inflation/rates" . if it does not come, then the post is moot…
once again, you are twisting things to try to make a point i am not even arguing.
if inflation hits 6-8& then corp bonds will hit 10-12% and the S&P will NOT grow earnings 5%
you also casually left out the part where he says folks 65 should have 65% of the port. in bonds…
he also says "6% on corp bonds"… when is the last bond you saw at 6%? they are almost all 8% and up now…
FTR, bogle has been saying this for the whole decade…the S&P's INDEX return over that time frame? -33%
luv them index funds……
the investopedia article is great…nice theory….although we both know that is not always true..
also, i never said "bonds are always better" just "better in high inflation /high interest rate environments"
i do not disagree totally with Seigle, it is Munger and Buffett who call him a "hack". I have no opinion of him other than his mutual funds have gotten shellacked..
so i guess i actually agree with buffett? when did I ever say i disagreed with him?
you still have not presented anything to refute my 1970's example…
are you saying "yes that is true, but…..?"
here is one from bogle….since you value his thoughts so..
http://books.google.com/books?id=il3_T8XlRwEC&lpg=PA37&ots=8_pzK8PWCq&dq=bogle%20high%20interest%20rates%20bonds&pg=PA46
that is annual return on treasuries..
notice the annual return for those who bought them at the peak of inflation late 70's early 80's? 15-20% annually on a treasury ..100% safe investment…
corp bonds bought at that time would have been much more than that as they would have paid an interest rate 3-5% higher than treasuries
this is point you seem to not want to admit….
now that Bogle says it can we put it to bed???????
Dude, you are just all confused.
First, the link you presented doesn't lead to any chart, but a book where John Bogle shows you that stocks deliver higher returns.
Second, Ker and I already wrote out all the points as to why this post is flawed: questionable data set with no sources, a time period that is specifically tailored to depress the returns on stocks, the effect of inflation on bonds, etc.
Third, what you're writing is so convoluted that it doesn't make sense to anyone who is financially literate, hence all the harsh criticism. Your ranting comes across as fanatical and illiterate.
Fourth, here is a more illustrative chart, with the S&P 500 graphed against corporate bonds as well as commodities:
http://www.cxoadvisory.com/blog/external/blog1-29-07/
It presents the exact same evidence that Ker and I have been telling you all along; that bonds can be a safe haven in certain, brief windows of time, but the longer-term record is crystal clear.
So unless you're timing the bond market perfectly, around recessions, which is implicit in the little "study" you produced, then bonds HAVE NEVER outperformed stocks. To bring the effects of hyperinflation into the discussion almost totally discredits anything you're saying about financial markets.
Let me guess: now these researchers at Wharton and Yale are wrong, too?
After reading Todd's followups and scratching my head over this thread, I got the impression that he's claiming that bonds are _less worse_ than stocks in a period of serious inflation.
That's arguable, as it gets around the fact that nominal rates rising pushes bond prices down. The trouble, as with all relative arguments, is that it suggests a hedger's strategy.
As far as timing is concerned, I'd say that this is a bad time to do so. The stock market's already been knocked flat, and seems to be recovering: it looks to me like another 1975, not another 1972. This point speaks to Ben's own point about timing.
Ben: "So you're going to disagree with Ivy League professors, disagree with Buffett, disagree with Bogle — all the greats, with credibility in spades."
As far as I know, Buffett has never said anything remotely similar to what you have suggested. Closest I have seen him say is that good companies with pricing power will do well during inflation. But as anyone would know from looking at the 70's, there are very few companies that have genuine pricing power. HE has also said bonds will perform poorly if inflatio was high but I'll bet he'll agree wtih me in the two scenarios I described (i.e. bonds undervalued; or stocks overvalued). Anyway, Buffett is a stockpicker and these general arguments on assets classes are not relevant.
The others your cite, Bogle, CXO Advisory, et al, do make the arguments you make. But then again, those are the ones that believe in efficient markets and I don't. For instance, Bogle thinks no one should ever select a security (i.e. stockpicking doesn't work). I obviously don't believe that. Bogle and others with similar thinking are also the ones that would probably consider it impossible that bonds can outperform stocks for 40 years. In fact, this is what happened recently (read the bottom article here). Anyone following Bogle, or even Jeremy Siegel to some degree, would have suffered something that was unimaginable to them. It would be truly shocking to these guys that bonds outperformed stocks from 1968 to 2009.
Ben: "So unless you're timing the bond market perfectly, around recessions, which is implicit in the little "study" you produced, then bonds HAVE NEVER outperformed stocks. To bring the effects of hyperinflation into the discussion almost totally discredits anything you're saying about financial markets. "
I don't agree with Todd; bonds are actually bad during high inflation unless they were undervalued (i.e. yields high) or stocks were overvalued (which means stocks can fall more than bonds). But I don't agree with you either…
This whole argument is based timing the market. Any time you introduce the notion of "high inflation" or "hyperinflation" or "deflation" or whatever, you are timing the market. You are separating time periods and forecasting future outlook.
Your argument, which is what is generally promoted by passive investors, efficient market proponents, and so forth, can be just as wrong as Todd's generalized view.
Ben: "Let me guess: now these researchers at Wharton and Yale are wrong, too?"
Of course they are. Not their numbers; but their conclusions. If we stay in a bear market for another few years, the biggest losers are going to be the passive investors who follow the advice of people like Bogle. Some of the biggest losses are actually being borne by pension funds and endowments (like Harvard), who basically closely follow the people you are referring to. For instance, almost every institutional fund has been heavily overweight stocks, at the expense of bonds, for the last few decades (in the 40's and 50's they were overweight bonds.) Why? For the same reasons you make and the sources you cite. Stocks beat bonds almost at all times and everyone and their dog knows that. Or so everyone thought. Yet, as that Barron's article I linked shows, bonds beat stocks (until March 2009 when it was published). I'll bet none of your sources would have ever considered that possible. Remember, the 1969 to 2009 period involved high inflation (bad for bonds) in the 70's and a huge bull market in stock in the 80's and 90's. Yet bonds beat stocks. (I'm a contrarian and think stocks are better than bonds here, unless we get deflation, but my point is that the efficient market theorists, as well as passive investors, have a simplistic view).
Anyway, just think about that Barron's article or go and do your own research. It's remarkable that bonds beat stocks from 1969 on…
Daniel Ryan: "That's arguable, as it gets around the fact that nominal rates rising pushes bond prices down. "
Yeah but Todd is comparing stocks versus bonds. The fact that bond prices fall doesn't mean much because stock prices will also generaly fall.
Daniel: "As far as timing is concerned, I'd say that this is a bad time to do so. The stock market's already been knocked flat, and seems to be recovering: it looks to me like another 1975, not another 1972. "
I think everyone responding here, Todd, Ben, as well as yourself, probably share the same stance and think inflation is likely. In that case, the 70's is comparable. I would not buy bonds, unless they were high yielding corporate bonds, in that case.
But I'm in the minority and actually think we may be stuck in a mild-deflation/low-inflation environment (like Japan or a mild version of the 1930's). In that case, bonds will likely outperform stocks. It's really tough to say and all of us are just guessing. The consensus is that the stock market has set its bottom and we may have started a new bull market. Many, including Warren Buffett, think valuations are attractive. I personally don't think valuations are attractive. Although I'm not expecting it, I can actually see the market dropping, in the extreme case, 30% to 50%. Bonds obviously will beat stocks if that scenario unfolds…
Dear Lord, now we've got some other guy chiming in on this asinine issue…
First, I cannot believe you linked that article regarding Treasuries and stocks. The stock market has been utterly devastated and Treasuries are in this massive bubble, so what other point does this anomalous "40-year" result make? All that it basically says is that it's time to get the hell away from Treasuries…
Second, if you actually read what I wrote above, I said that Buffett advised in his "Buy American" article to invest in equities. Buffett remarks: "my money says equities". He does say that his money says "corporate bonds".
This entire conversation is both comical and a warming sign. We've got some kind of Third-World guy advising a Jew on credit markets and bonds, and Todd Sullivan is going to begin managing money. What theater!
The very fact that all this is happening shows how finance has been way overblown over the past few decades. Everybody and their mother now has an opinion about stock valuations and bond markets and inflation and the '70s and the Federal Reserve and China's economy…
With my money, I'm getting the hell away from all of this. Jim Rogers is right in saying that the fortunes over the next generation are going to be made not by paper shufflers, but developers of physical assets, like farms or energy assets or mines or any type of ugly thing that no one wanted to do for the last fifty years.
Teach yourself physical science. Learn to grow things. Pick up a trade. Do something useful.
with all the talk about what Buffett has "said", what has he "done"
what have his last large transactions been? of the top of my head it was $8- $9B?
GS debt "with a warrant kicker" to quote Warren
Dow Chemical debt convertible
GE preferred (quasi debt)
Harley Davidson debt
he also at the time sold equities to fund the GS deal
those deals dwarf any equity investment he has made…
admittedly those were distressed deals (except Dow) and buffett got above now market rates for the debt plus warrants at the time. one can assume when (if) inflation comes and rates rise, the warrants will then compensate for the then at or below market rates that debt is then getting….
OR buffett does not see inflation or interest rate increases in the future….of course that would go against public statements to the contrary..
can anyone explain why 1978-82 was not the best time to buy bonds in the last 50 years?
when rates fell 3-4 years laster most of that debt was getting 20%+ YTM. of course that was also the peak of the inflationary cycle…
those return also crushed the S&P return over the next 10-12 years…
Sivaram: "Yeah but Todd is comparing stocks versus bonds. The fact that bond prices fall doesn't mean much because stock prices will also generaly fall."
Acting on it would require a hedging strategy, though. My last post had begun to runneth over, so I didn't discuss it: I just put a hint on the timing issue.
Todd: "can anyone explain why 1978-82 was not the best time to buy bonds in the last 50 years?"
I can say why it was _claimed_ that bonds were a lousy choice at that time. The goldbugs were flying high, and they were all convinced that inflation was going to come roaring back. The pain of disinflating, so they claimed, made it politically impossible to wring out inflation from the economy. By 1981, it was generally assumed that bondholders were permanent suckers in the inflation game. Tales of poor Aunt Sally, who had bought a 4% coupon only to see her interest payments ravaged by inflation, were everywhere.
It was at that time when bonds were a screaming buy. Bonds in 1981 presented a classic value opportunity, if one was perceptive enough to see that Volcker & Co. were serious about squeezing out inflation. That was the crucial connection, which would have had to be made in defiance not only of conventional wisdom but also of then-accepted common sense. It was a perfect time for a naive kid who hadn't heard what "everybody knew" [which proved not to be so.]
That was the time to buy bonds. You see, Todd, your study is based upon one crucial assumption. If the CPI goes above 7% for a sustained amount of time, your model assumes that the Fed will "go Volcker" and squeeze inflation down to a more acceptable 2-4%. Trouble is, we don't know how far it will go.
Ben: "Jim Rogers is right in saying that the fortunes over the next generation are going to be made not by paper shufflers, but developers of physical assets, like farms…"
I can almost hear it now: "Live like Neil Armstrong…buy a farm!" [That's what he ended up doing.]
Yes! Daniel is exactly right and he knows what he's talking about.
In essence, the three of us — me, Daniel, Kerbouchard — are trying to make the same points.
My only remark on physical assets is that that's where the imbalances and shortages are. Iron ore and lead mines, agricultural products, anything involving energy.
You might be shocked to know that over the past few years, the fastest appreciating real estate was not in New York or Los Angeles, but Mid-West corn-farming land. This is another instance where the exact right thing to invest in is the area where practically nobody is looking.
Everyone is looking to invest in the last bull market: finance, hedge funds, investment banking. There are no shortages here. A major percentage of the U.S. economy was built on finance and financial gambling.
Skate to where the puck is going, not to where it was.
Ben: "Everyone is looking to invest in the last bull market: finance, hedge funds, investment banking. There are no shortages here."
That's right. As far as bonds are concerned, valuation opportunities in well-chosen corporate bonds can't change the fact that the U.S Treaury bond market is nowhere near a long-term buying point. Deficits are ballooning; foreign creditors are complaning, and one of them is slowly following through on their complaints; the long-term Treasury-bond bull market is over 25 years old, which makes it quite long in the tooth; and, the "bond vigilantes" seem to be asleep at the switch: if inflation comes back, they will wake back up.
Regarding sectors, I don't know of any that's generally considered "dead in the water." On the other hand, as Ben indicated, commodities are waking up. So are associated investments, such as the Midwest farmland he mentioned.
If anyone here's interested: some precious-metals firms got squeezed even when gold was rising, because their mining costs went up with it. I don't have the data in memory, but that may be (even more) the case for some commodities producers. The ones that sell commodities that are currently going through a supply squeeze might also be suffering on account of an earlier margin squeeze. Margin squeezes tend to disappear when growing suppliers' capacity meet temporary shutdowns later recovered from.
There will be a time for bonds, and Todd's model may well have tapped into a kind of political business cycle. I have to say, though, that it's too early for U.S. bonds in general. A corporate-bond specialist may very well make a good return buying solid corporate bonds that are currently under a cloud. The overall bond-market picture, however, suggests selling them when they're no longer undervalued with respect to Treasuries. They may no longer be a value opportunity next year.
Dan,
One irony of this entire debate is that I am actually an investor in credit securities, which I accumulated throughout this crisis.
I wouldn't call myself a credit expert, but my business partners definitely are, and my portfolio is filled with some relatively esoteric stuff — CLOs/leveraged loans, trust preferreds, CMBS, etc., all of which were the most undervalued markets and subsequently have done astonishingly well.
If one purchased these securities early this year and late last year, there has been a furious bull market underway. The entire TruPs (trust preferred) market doubled. That would be as if the Dow Jones index doubled.
But those guys who were talking about Treasuries are just totally ignorant and living on another planet. Buying Treasuries is analogous to saying, "maybe subprime loans are a good buy in 2006, because they've done well over the past few years". Treasuries are in a huge bubble and only have one way to go. They are probably the single worst investment a person could make right now.
But yes, I am largely a credit and real estate investor, but I would love to get involved with physical commodities businesses over the coming years. There is a major difference between doing this and, say, investing in ETFs as Todd Sullivan recommends (as if the guy couldn't be a bigger bozo).
If you buy a gold ETF or bullion or whatever, basically your solely betting on the direction of the price. You're buying at x and hoping to sell at 2x. This is pure speculation.
Yet investing in a physical commodities business is like owning, say, a piece of commercial real estate in a bull market. Your property is worth more, and your rents go up. In other words, you're SELLING the commodity at higher prices, not buying it.
Buying ETFs or futures is generally the Greater Fool Theory, or at least for 98% of investors. But I greatly look forward to developing commodities businesses over the coming years.
And Todd's going to be developing his businesses, in anticipation of the last bull market. He's going to slick his hair back like Gordon Gekko and tell us about how Lehman Brothers is a great place to work and how you want your money in Florida condos and Arizona McMansions.
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