Stocks and Bonds

The Monday January 9, 2012 Wall Street Journal had a article titled "Stocks or Bonds? The Pros Say..." This article gives great info on the historical performance and future of the S&P 500 Stock Index and Long Term US Treasury Bonds. I will add my comments on why an investor would own US Stocks or long term US Treasury Bonds. At the end is a short story titled The Tennessee Preacher that seems appropriate for this year.


Vanguard

Sluggish retail sales data were announced this week following a report that consumer borrowing increased in November by the highest amount in a decade. This suggests that while spending isn't particularly strong, consumers are nonetheless continuing to spend and provide moderate support for the overall economy. For the week ended January 13, the S&P 500 Index rose 0.9% to 1,289.09 (for a year-to-date total return—including price change plus dividends—of about 2.6%). The yield on the 10-year U.S. Treasury note fell 9 basis points to 1.89% (for no change year to date).


Future of US Stocks versus US Treasury Bonds

Here is the information from the WSJ article:

1) Over the past 30 years the S&P 500 index had an average annual return of 11.03% and long term Treasuries had an average annual return of 10.98%.
2) From 1926 through 2011 the S&P 500 index had an average annual return of 9.8% and long term Treasuries had an average annual return of 5.7%.
3) From 1926 through 2011 the S&P 500 index was 6-7% higher than the inflation rate and long term Treasuries was 2-3% higher than the inflation rate.
4) From 1956 through 1981 the S&P 500 index had an average annual return of about 10% and long term Treasuries had an average annual return of about 2.5%.

If we compare these time periods we see that the S&P 500 index was more consistent than long term Treasury Bonds. During the last 30 years, long term Treasury Bonds returned about twice the return since 1926 and about 4 times the return during 1956 to 1981.

So why did this happen? About 30 years ago, during a period of stagflation, the long term Treasury interest rate was about 18%. Leading up to 30 years ago, long term Treasury rates rose significantly which hurt performance. During the last 30 year period was an unprecedented drop in interest rates. It is interesting that the last time long term Treasury Bond rates were this low was about 60 years ago.

So what does this mean for the future of the S&P 500 index and long term US Treasury Bond rates? The data suggests that the S&P 500 index will continue to increase. Since long term US Treasury Bond rates are at a 60 year low it means that these rates will go up which will hurt performance.

So why would an investor own a mutual fund of US Stocks? The answer is higher growth with some volatility. So why own a mutual fund that invests in long term US Treasury bonds. The answer is that I would not instead I would ownn other types of bonds. A blend of US Stocks and bonds does give a blend of growth and more consistency.


The Tennessee Preacher

An old Tennessee country preacher had a teenage son, and it was time the boy should give some thought to choosing a profession. Like many young men his age, the boy didn't really know what he wanted to do, and he didn't seem too concerned about it. One day, while the boy was at school, his father tried an experiment. He went into the boy's room and placed four objects on his son’s desk.

1. A Bible.
2. A silver dollar.
3. A bottle of Jack Daniels whisky.
4. A Playboy magazine.

“I'll hide behind the door,” the old preacher said to him-self. “When he comes home from school, I'll see which object he picks up. If it's the Bible, he's going to be a preacher like me, and what a blessing that would be! If he picks up the silver dollar, he's going to be a businessman, and that would be okay, too. However, if he picks up the bottle, he's going to be a no-good drunken bum, and Lord, what a shame that would be. And worst of all if he picks up that magazine he's going to be a skirt-chasing womanizer.”

The old preacher waited anxiously, and soon heard his son's footsteps as he entered the house and headed for his room. The boy tossed his books on the bed, and as he turned to leave the room, he spotted the objects on his desk. With curiosity in his eyes, he walked over to inspect them. Finally, he picked up the Bible and placed it under his arm. He picked up the silver dollar and dropped it into his pocket. He uncorked the whiskey bottle and took a drink, while he admired the centerfold in Playboy.

“Lord have mercy,” the old preacher whispered disgusted-ly. “He's gonna run for Congress.”