‘Rewrite Finance Books’: Long-Dated Bond Returns Crush Stocks

(Bloomberg) -- Everyone riding the S&P 500 roller coaster may feel wheezy looking at the vanishing returns of stocks versus bonds right now.

Between the coronavirus-spurred market carnage and the crazy bond rally -- newly emboldened by the Federal Reserve -- long-dated Treasuries now handily beat large caps across one, three and five-year horizons.

That’s according to the total returns posted by the world’s biggest exchange-traded funds tracking the asset classes with around $248 billion combined. The famous SPDR S&P 500 ETF Trust, or SPY, and the iShares 20+ Year Treasury Bond ETF known as TLT.

The TLT-SPY spread is a whopping 18 percentage points over the past five years. In the past decade, you’re still better off with equities but the gap has just narrowed to about 12 percentage points from as much as 144 percentage points less than a month ago. And stock volatility is hurting risk-adjusted returns by the day.

“It is incredible -- they’ll have to rewrite finance books,” said Abi Oladimeji, chief investment officer at Thomas Miller Investment Ltd. in London. “There are extended periods where risk doesn’t necessarily pay. And unfortunately a lot of the time you live through those and for a lot of investors, they only realize it after the fact.”

Where now? On the plus side, compared with 10-year Treasuries, stocks are looking the most attractive on record in terms of their dividend yield. Or since 2012 in terms of their earnings yield. And with rates so low, it’s going to be harder to eke out capital gains from Treasuries going forward.

On the flipside, shares could easily get cheaper as widespread risk aversion, a souring economic outlook and monetary easing spur an intensifying dash to havens.

“Beyond a short-term horizon, the real determinant will be the growth outlook, the inflation outlook, the policy outlook,” said Oladimeji. “An analysis of those factors will not lead you to bet against bonds right now.”

How much investors demand to be compensated in order to hold stocks over the discount rate, or the equity-risk premium, has always been hard to estimate. It is typically derived from Treasury bills, though it depends on your investing horizon. Compared to these short-term notes, the S&P 500 does much better on longer time frames, though it’s still a loser over the past one and two years. No wonder money-market funds have posted the largest jump in assets since August 2007 to $3.78 trillion.

Humble T-Bill

As stocks slide closer toward December 2018 lows, here’s another awkward fact for people who are paid to manage money: While stock indexes win out over the long term, most single names actually do not fare better than even the humble T-bill.

Nearly 60% of American stocks have lagged the short-term paper in their lifetimes even as of 2019, according to data compiled by Arizona State University professor Hendrik Bessembinder. Or to put it another way, wealth creation through equities is incredibly skewed toward a handful of names.

Of course, investors don’t blithely snap up government obligations for their price appreciation prospects. Instead the asset class is touted for its reliable hedging power over the decades. But don’t count on bonds always being the haven asset, warns David Blitz, head of quantitative research at Robeco.

While the two are generally expected to move in different directions, they also have a record of suddenly plunging in tandem, such as around the 1994 rate hike and during the oil crisis in the 1970s.

Consider last Wednesday, when the two assets saw their sharpest combined loss since TLT was born in 2002 -- a reminder their inverse relationship doesn’t always hold during crises.

Still, investors might find some solace in research less concerned with a few weeks of market gyrations. Quant giant AQR Capital Management LLC projected in January U.S. stocks will return 4% annually over the medium term after adjusting for inflation, compared with around 0% for 10-year U.S. Treasuries.

Hold on and sit tight remains the investing mantra.

©2020 Bloomberg L.P.