Wednesday, August 17, 2016

Stocks vs Bonds vs Jeremy Siegel

I was invited by Professor Jeremy Siegel of Wharton for a public debate on stocks versus bonds. He, of course, favored stocks and I advocated Treasury bonds.

At one point, he addressed the audience of about 500 and said, “I don’t know why anyone in their right mind would tie up their money for 30 years for a 4.75% yield [the then-yield on the 30-year Treasury].” 

When it came my turn to reply, I asked the audience, “What’s the maturity on stocks?” I got no answer, but pointed out that unless a company merges or goes bankrupt, the maturity on its stock is infinity—it has no maturity. My follow-up question was, “What is the yield on stocks?” to which someone correctly replied, “It’s 2% on the S&P 500 Index.”

So I continued, “I don’t know why anyone would tie up money for infinity for a 2% yield.” I was putting the query, apples to apples, in the same framework as Professor Siegel’s rhetorical question. “I’ve never, never, never bought Treasury bonds for yield, but for appreciation, the same reason that most people buy stocks. I couldn’t care less what the yield is, as long as it’s going down since, then, Treasury prices are rising.”

Of course, Siegel isn’t the only one who hates bonds in general and Treasuries in particular. And because of that, Treasuries, unlike stocks, are seldom the subject of irrational exuberance. Their leap in price in the dark days in late 2008 is a rare exception to a market that seldom gets giddy, despite the declining trend in yields and related decline in prices for almost three decades.

Stockholders inherently hate Treasuries. They say they don’t understand them. But their quality is unquestioned, and Treasuries and the forces that move yields are well-defined—Fed policy and inflation or deflation are among the few important factors. Stock prices, by contrast, depend on the business cycle, conditions in that particular industry, Congressional legislation, the quality of company management, merger and acquisition possibilities, corporate accounting, company pricing power, new and old product potentials, and myriad other variables.

Also, many others may see bonds—except for junk, which really are equities in disguise—as uniform and gray. It’s a lot more interesting at a cocktail party to talk about the unlimited potential of a new online retailer that sells dog food to Alaskan dog-sledders than to discuss the different trading characteristics of a Treasury of 20- compared to 30-year maturity. In addition, many brokers have traditionally refrained from recommending or even discussing bonds with clients. Commissions are much lower and turnover tends to be much slower than with stocks.

Stockholders also understand that Treasury's normally rally in weak economic conditions, which are negative for stock prices, so declining Treasury yields are a bad omen. It was only individual investors’ extreme distaste for stocks in 2009 after their bloodbath collapse that precipitated the rush into bond mutual funds that year. They plowed $69 billion into long-term municipal bond funds alone in 2009, up from only $8 billion in 2008 and $11 billion in 2007.

Another reason that most of those promoting stocks prefer them to bonds is because they compare equities with short duration fixed-income securities that did not have long enough maturities to appreciate much as interest rates declined since the early 1980's.

Investment strategists cite numbers like a 6.7% annual return for Treasury bond mutual funds for the decade of the 1990's while the S&P 500 total annual return, including dividends, was 18.1%. But those government bond funds have average maturities and durations far shorter than on 30-year coupon and zero-coupon Treasury's that we favor and which have way, way outperformed equities since the early 1980's.