Wednesday, August 4, 2010

Yield Wins in the Long Run

WSJ (hat tip Abnormal Returns):

Bonds continue to trounce stocks, sending mixed signals to investors and raising the question: Are stocks too cheap or are bonds too expensive?

After consistently lagging behind bond performance this year, stocks appear historically cheap compared with bonds, offering investors reason to favor stocks, particularly if they are optimistic about the economic outlook.

EconomPic has detailed this quite a bit over the past few months:
Back to the WSJ detailing how things have played out:
So far this year, the stock market's total return is slightly negative, while normally staid investment-grade corporate bond returns are up nearly 8%, according to Bank of America Merrill Lynch indexes. Even risk-free Treasury returns are up 6%.

This equity-like performance of high quality bonds can not continue. At some point the level of yield... wins. With the current yield to worst of the "Barclays Agg" index at less than 2.6%, investors expecting anything more than 2.6% over the next 4-5 years (i.e. the duration of the index) will be disappointed.

As for risk assets... as I detailed in my post Investing in a Low Return Environment my guess is that while high real returns are possible, there is a lot of risk out there.

And THAT'S the problem with investing these days (and not just with bonds). With risk-free rates hovering near zero, an investor must take a much larger amount of risk to achieve any level of absolute return. This concept is even more meaningful for an investment in risk assets, such as equities and commodities, as the downside risks of those asset classes are MUCH higher than even the worst case rising rate scenario on an investment in the BarCap Agg.
Source: Barclays Capital