Advisers should approach stocks cautiously

No wonder investors have lost faith in the stock market. A new report from The Leuthold Group LLC, a Minneapolis-based research firm, shows that the total return on 10-year Treasury bonds outpaced the Standard & Poor’s 500 stock index for all holding periods from one to 25 years through March 31. For the 30- to 50-year period, stocks barely outperformed bonds.

In other words, the promised reward for taking on the added volatility of stock returns seems to have evaporated in recent years.

“Even [for] investment time frames that could be considered “generational’ [30 to 50 years], the small margin of outperformance by the S&P 500 hardly compensates for the sleepless nights” associated with owning stocks, according to the report.

To be sure, the return on stocks looks better in the wake of the S&P 500’s 120-point rally from July 10 to Aug. 4. Still, the market’s nascent recovery hasn’t eliminated all the advantage of Treasuries.

On the bright side, the report suggests that the stock market is the place to be in the years ahead. When end dates other than the end of this year’s first quarter were examined, it found that stocks outperformed Treasuries in 212 of the 333 one-year holding periods, 233 of the three-year periods, 257 of the five-year periods, 284 of the 10-year periods, 308 of the 15-year periods and 325 of the 20-year periods.

That means that though nothing is guaranteed, the stock market is more likely to go up over the next several years than down. It also means that Treasury prices are more likely to go down than up and that stocks will likely provide better returns than Treasuries.

“Today’s unusual performance relationship between stocks and bonds points to the likelihood of strong relative stock market performance going forward,” the report said.

Of course, careful consideration of client goals is a necessary precursor to any move.

The situation at the end of the first quarter was an anomaly. Making investment decisions based on that anomaly could easily lead investors into trouble.

Indeed, other analysts have suggested that the risk premium offered by stocks over bonds might not be as great as it appeared to be in the 1980s and 1990s, for a number of reasons.

First, the mountain of debt the federal government is building up be-cause of plunging income tax receipts and stimulus spending is likely to push up interest rates significantly, and high interest rates dampen economic growth.

Higher taxes are likely to be needed to pay the interest on that debt and to finance health care reform, further dampening economic growth.

Furthermore, more-stringent capital requirements for banks will likely reduce lending to small and startup firms, hurting economic growth. And many economists think that we are headed into a period of high inflation as the economy recovers.

So though advisers may encourage clients to hold on to their stock positions or to get back into the market if they have left it, they must be careful not to oversell likely long-term equity returns. Equity returns seem unlikely to equal the long-term returns registered from 1926 to 2000.

Slower economic growth won’t allow it.