Issue 46 • OCTOBER 7, 2009

Gentlemen Prefer Bonds

For all the ballyhoo about the 50%-plus stock market rally since March, bonds have actually been an investor’s best friend since the credit crisis intensified a year ago, and with good reason.

Although fixed income markets and many bond mutual funds also took a hit during 2008, bonds held up MUCH better than stocks on a total return basis. While stocks have grabbed a lot of headlines during the recent rebound rally... high quality corporate and government bonds actually bottomed earlier and have rebounded even more than equities.

Government bonds, of course, benefited from an enormous flight to quality, starting in mid-2007. As a result, Treasuries were one of the very few asset classes that rallied during the devastation of 2008.

Bonds up More than Stocks in Past Year

In spite of relatively low yields, government bonds, as measured by the iShares Barclays 20+ Year Treasury Bond ETF (TLT), surged about 11% over the past year while the S&P 500 Index was DOWN -9.3% over this same time frame.¹

Investment grade corporate bonds have done even better, soaring +24.6%. And, high-yield bonds were up +14.7% on a total return basis, also outperforming stocks.²

And it’s not simply about how well bonds have performed lately. Over the long term, a fixed income allocation acts as an important stabilizer for most portfolios ... and particularly for investors nearing retirement who may not be able to take on much risk.

During the 1990s, bonds performed fairly well, with U.S. corporate and government bonds up about +7% per year over the decade, but that couldn’t compare with stocks, which were soaring back then.³

In fact, from 1990 through 1999, the S&P 500 appreciated more than +15% per year, but such returns are certainly not the norm.⁴ They were actually far above the historic average annual return for stocks. Not surprisingly, stock funds, rather than bond funds, attracted the majority of new cash flows in the 90s, as investors embraced a culture of equity ownership, but, as we all know, the tables have turned dramatically since 2000.

BONDS for the Long Run?

Since 2000, corporate and government bonds have returned about +6.3% annually ... a respectable return, but bonds look even better when compared to stock returns this decade. Over this period, the S&P 500 LOST -3.3% per year in terms of price depreciation.⁵

Looking at stocks versus bonds on a total return basis over the entire 20-year period is a real eye-opener. Here’s the score from 1990 through September 2009:

U.S. stocks UP +355%, including dividends ... not bad

U.S. bonds UP +467%, significantly better ... and with much less volatility!⁶

This means that $100,000 invested in stocks over the period would have grown to $455,000 ... but that same $100,000 invested in bonds would have grown to $567,000. Which asset class would you want to have owned?

The numbers alone speak for themselves, but when you also consider the lower risk assumed by investing in bonds versus stocks, then the picture is even clearer. Boring old bonds outperformed stocks by a difference of more than $100,000 in total return ... over the last two decades … it’s no wonder gentlemen prefer bonds!

Of course not ALL bonds are created equal. There are perhaps millions of individual bonds available to investors worldwide, and thousands of fixed income mutual funds, a dizzying array in fact.

Choosing the right mix to suit your financial needs is the tricky part, but in my view, the most important part is to at least have some bonds included in your mix.

Many investors fall into one camp or another. Either they invest mainly in stocks (or stocks funds and ETFs) for long-term capital appreciation or they invest mainly in bonds (or bond funds, CDs and money markets). There may not be much mixing between the two, but I think that’s a mistake and a missed opportunity.

Fixed Income Under-Investment

If anything, investors today are drastically underinvested in bonds. U.S. households have about 7% of their assets in government and non-government bonds. 24% of their assets are invested in equities ... which have declined -28% since 2000. Another 30% of U.S. investor assets are in real estate ... with home values down about 30% since 2006.⁷

Perhaps it’s time for investors to consider rebalancing their long-term portfolios and perhaps boost the mix of boring old bonds. That’s because a fixed income component can help add stability to your portfolio over time.

Granted, nearly every asset class plunged in value during 2008, including global stock markets, and most bond markets did too, but investors with a good mix of both stocks and bonds might have fared much better ... certainly better than stock only investors.

Large-cap U.S. stocks dropped -37% last year, while foreign stocks plunged -43%. In comparison, an equal mix of different types of bonds including Treasuries, municipals and corporate bonds (both investment grade and high yield) only declined
-4.3% during 2008.⁸

Bonds were still down overall, that’s for sure, but a portfolio that had, say a 50/50 mix of stocks and bonds would have held up much better, even during last year’s freefall.

Turning to today, both stock and bond markets have surged in recent months, and there’s a lot of debate now about whether the recent rebound in our economy will prove sustainable. Naturally, there’s much uncertainty about corporate profit growth in this world of high and rising unemployment, while consumers are saving more and spending less.

Into the next decade, big gains may be harder to come by... but stock investors will need to see stronger economic and profit growth if they expect to see stocks gain much more from here.

On the other hand, fixed-income investors don’t need to see the economy get much better to be reasonably secure in their bond holdings — the economy just doesn’t need to get any worse.

That’s one good reason why investors should carefully consider their current portfolio mix of bonds and stocks right now.

Good investing!

Mike Burnick
Director of Research & Client Communications
Weiss Capital Management, Inc.

P.S. Fixed income securities can help add stability to your overall investment portfolio, but many investors are under-invested in bonds because of today’s ultra low interest rates. Next week, we’re hosting a special Web event: Earning Higher Income in a Low Yield Market. There’s no cost or obligation to attend. To learn more, go here now.

¹ Bloomberg data: 10/6/09
² Ibid.
³ Ibid.
⁴ Ibid.
⁵ Ibid.
⁶ Ibid.
⁷ Gluskin Sheff Economic Commentary, 7/31/09
⁸ Ibbotson, FMRCo (MARE) as of 12/31/08