If you've been telling your clients that stocks beat bonds over the long term, you might want to mention that the long term has been getting steadily longer.
Long-term Treasury securities have outperformed the Standard & Poor's 500 stock index for the past 10 years. The SPDR S&P 500 ETF (SPY) has gained an average 7.27% over the past decade, according to Morningstar Inc. But the iShares 20+ Year Treasury Bond ETF has gained an average 9.31% during the same period.
From a very long-term historical perspective, this is an anomaly. Long-term government bonds have earned an average 5.64% a year since 1926, while large-company stocks have gained an average 10.01% a year. (Both figures assume reinvested interest and dividends.)
Why have stocks done so poorly, and Treasuries so well?
• Punk growth. “The past 10 years have had the slowest rate of GDP growth since the 10 years ended 1939,” said John Lonski, managing director and chief economist for Moody's Capital Markets Research Group. U.S. GDP has averaged an annual growth rate of 1.3% in the past decade, versus 1% for the 10 years ended 1939. "Extraordinarily slow growth over the most recent 10-year span explains why defensive investments in Treasury bonds did so well,” Mr. Lonski said.
• Bear markets. From 2007 through 2009, the S&P 500 saw its worst bear market since the Great Depression.
• Bull markets. For bonds, that is. A decade ago, the 30-year bond yielded 5.1%. The tumble in yield to below 1.4% means that bond price have rallied strongly.
• Falling overseas rates. Money moves to where it earns the most interest with the least amount of risk, and right now, that would be the U.S. The bellwether 10-year Treasury note currently yields 1.39%, below the levels it reached during the financial crisis. But the 10-year British government note yields 0.76% and the 10-year German government note yields -0.18%.
So far, intermediate-term Treasuries have yet to beat the S&P 500, although they're close. The iShares 7-10 Year Treasury Bond ETF (IEF), for example, has had an average gain of 6.65% over the past 10 years.
This isn't the first time that bonds have beaten stocks over a 10-year period. Bonds outperformed stocks in the 10 years ended 2012, 2011, 2010, 2009, 2008, 2007, 2002, 1978, 1977, 1974, 1940, 1939, 1938, and 1937, according to Morningstar/Ibbotson data. Typically, those periods coincide with stretches of wretched stock market performance, such as the period following the technology meltdown from 2000-2001, the 1972-1973 bear market, and the Great Depression.
Nevertheless, it's an unusual turn of events, and one that advisers should consider. One particular worry: Both bonds and stock valuations look stretched at this point. For clients with a traditional split of 60% stocks and 40% bonds, the current market could be worrisome, said David Kabiller, founder and head of business development at AQR.
“It's fair to say that today, the engine for most core portfolios had a good run,” Mr. Kabiller said. “Now it's not cheap.”