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Stock Lovers Missing a Bond ExperienceBy Jane Bryant Quinn
Sunday, August 4 1996; Page H02
A common opinion among investors seeking the most from their money is that bonds are a waste of time. Over the long run, stocks have greatly outperformed them. So if you're investing for retirement in 15 or 20 years, why own bonds at all?
You might be about to find out. Over five-year periods, you don't know which type of asset will do the best -- and for the average investor, five years is a long time indeed.
Furthermore, the focus on stocks since 1982 has obscured the extraordinary performance of bonds. The United States has recently lived through the greatest bull market of all time in both stocks and bonds.
Long-term U.S. Treasury bonds outdid stocks (as measured by the Standard & Poor's 500-stock index) in seven of the past 14 years, reports Steve Leuthold of the Leuthold Group in Minneapolis. From 1982 to 1993, bonds just about kept up with stocks, although since then, their gains have slowed.
Here's the case for bonds today:
The rise in long-term interest rates earlier this year should slow the economy. That means less demand for borrowed money, hence lower interest rates.
When interest rates fall, the market value of bonds and bond mutual funds goes up. If the yield on long-term Treasuries drops by 1 percentage point (to 6 percent, from a bit over 7 percent today), you would earn a total return of 21 percent over the next year, Leuthold says. (A bond's total return is the interest payment plus the gain or loss in market value.)
If the economy slows, so will the rate of increase in business profits. While bonds are going up, stock prices might be going down.
Perhaps the recent stock market decline is essentially over (the Dow Jones industrial average is now down only 1.7 percent from its peak this year while the Nasdaq index of smaller stocks has dropped 10 percent). But then again, perhaps not -- especially if the expected slowdown worsens into recession next year. If that happens, stocks will be a goner.
If the forecast of a slowing economy turns out to be wrong and business keeps barreling ahead, bonds present only a small risk. Interest rates would go up in a continuing strong economy, which would depress the price of bonds. But Leuthold doubts that rates would rise by very much.
The worst-case scenario for rates, in his opinion, is a 1 percentage point increase in long-term Treasuries over the next year, to 8 percent. That would produce a one-year loss in total return of about 4 percent. Such a rise, however, almost certainly would stop the economy, bring rates down and turn bonds back into a winner.
So there's the bond bulls' argument: Bonds have more potential for gain than stocks over the next year or more, and less potential for loss.
This is not a brief for jettisoning stocks (although Leuthold has; his Leuthold Asset Allocation Fund is only 9 percent exposed to equities). Most long-term investors feel they can't predict what the market will do, or when.
On the other hand, stock market lovers need to give bonds more respect. Stocks aren't always a one-way street. Bonds can be almost as volatile as stocks, but they tend to rise and fall at different times. So if you own both stocks and bonds and average their performance together, you have a more stable portfolio than if you owned only one of those assets. It also makes sense to invest extra money in an asset whose value is down, because you are buying at a better price.
But remember that bonds aren't the steady investment that some investors think. Since 1993, long-term bond prices have fluctuated more than 20 percent, up and down, in a single year, says economist H. Bradlee Perry of David L. Babson & Co. in Cambridge, Mass.
Medium-term bonds (maturities of five to 10 years) fluctuate much less. Since 1982, they also have produced a lower total return than you would have gotten from long-term bonds. Over other periods, however, they have done just as well as long-term bonds, and with less risk.
These ups and downs are most visible in bond mutual funds, whose prices are easy to follow every day. For a comforting sense of stability and steady yield, consider buying individual bonds instead.
Next: Bonds vs. bond funds