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What's safer: holding a 10-year Treasury bond until maturity or spending the next ten years in the broad U.S. stock market? Finance course books say Treasurys, but current conditions favor stocks.
In Monday's Wall Street Journal, Jeremy Siegel and Jeremy Schwartz of WisdomTree, an investment fund company, argue that bonds are in a bubble and stocks are a good deal. They're a smidgen too bullish for me. "The corporate sector is churning out record profits," they note, but as I've written here, profits are due for a tumble, and share prices could easily have further to fall.
But for an investor with a decade ahead of him, four signs suggest Siegel and Schwartz are right about stocks now being the better place to put cash.
First and most important, stocks pay more. The 10-year Treasury yield is "indistinguishable from zero," says Rob Arnott of Research Affiliates, an investment firm. That is, the 10-year Treasury now pays just 2.1%, near historic lows. And prices for ordinary goods and services rose 3.6% over the past year, according to the U.S. Bureau of Labor Statistics. When investment returns are erased by rising consumer prices, the result is a return of zero--or less--for investors.
Stocks, meanwhile, pay 2.3%, judging by the indicated yield of the S&P 500 index. That's unusual. When stock yields topped the 10-year Treasury yield in 2008, it was the first time since 1958. Bond yields are usually larger because stock dividends tend to grow over time and bond coupons don't, so bond buyers typically want to be compensated for this.
They're not being compensated now, however; The choice is between stocks' higher and rising yield and bonds' lower and flat one. That's the second reason to favor stocks. The Treasury investor, assuming he can reinvest his coupon payments at 2.1%, will end up with about $23 in return for each $100 invested after 10 years. The stock investor, if dividends increase by 5% a year and he reinvests his payments, will have $35 in return per $100 invested, assuming share prices go nowhere.
The third reason is that stocks have a better chance of keeping up with inflation. Those rising dividends tend to attract income-hungry buyers, who push up prices. Recent flops in the stock market have laid rest to the myth that stocks always beat bonds over long time periods, but let's not overstate the case. Between 1926 and 2010, U.S. stocks have an 86% win rate versus long Treasury bonds during rolling 10-year periods, according to Arnott. Look further back in the data to when stocks weren't as generous, and the rate is nearly as convincing. Stocks beat bonds during 71% of 10-year periods between 1802 and 2010.
Reason number four: Dividends have rarely looked safer. Banks quit on their payments during the 2008 financial crisis, which had the effect of purging the market of its least-dependable payers. Today's payments are 29% of S&P 500 profits. That's the lowest level since 1900, and perhaps in history, according to research by Bank of America Merrill Lynch. So companies seem more likely to raise their payments than reduce them, even if profits stall or dip.
All this does not amount to a glowing outlook for stocks. Daily swings of 3% or more in stock market value are both unusual by historic standards and plentiful this summer. Economists have slashed growth forecasts for most rich economies, and many put the chances of renewed U.S. recession at a coin flip. The S&P 500 index of large American companies has already lost 10% this year. For an investor who plans to spend his cash a year from now, better to suffer a slightly negative return after inflation but keep his principal safe, just in case the stock market does something violent.
For the saver with a decade to wait, however, the numbers suggest stocks are indeed now less frightening than Treasury bonds.
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