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Jonathan Burton's Life Savings Archives | Email alerts
Jan. 9, 2012, 12:01 a.m. EST
By Jonathan Burton, MarketWatch
SAN FRANCISCO (MarketWatch) "” With so much volatility in stocks, many investors have increasingly favored the relative security of bonds and bond mutual funds.
That may be a mistake.
Using history as their guide, and weighing current stock valuations and interest rates, various investment pros believe stocks have a much better chance than bonds to beat inflation in the long run.
That isn't to say they are particularly bullish on stocks. It's just that they are profoundly pessimistic when it comes to bonds.
As a result, the consensus among the investment experts interviewed for this article is that U.S. stocks will outperform long-term U.S. government and corporate bonds over the next 20 to 30 years and resume their traditional role as the safer hedge against inflation.
"I certainly wouldn't get out of the stock market," said Jack Bogle, founder of Vanguard Group, which offers funds of many types of investments, including stocks and bonds. "The risks we face today are deeply serious," he said, "but the odds are that stocks will do better" than bonds.
It would take very little for equities as a class to post better returns than they have in recent years. In the so-called lost decade from 2000 through 2009, the return on the Standard & Poor's 500-stock index /quotes/zigman/3870025 SPX -0.25% , including dividends, averaged a negative 0.9% per year, according to investment researcher Morningstar Inc.
But even at current prices, such large-cap stocks probably won't deliver the spectacular 18% annualized average gains that a generation of buyers enjoyed from 1980 to 1999. Still, right now stocks, particularly dividend payers, look more attractive than bonds "” especially if down the road there's resurgent inflation, which whittles away fixed-income returns.
"The bond outlook is extraordinarily bad," said Jeremy Siegel, a Wharton School finance professor and author of the best-selling "Stocks for the Long Run." Bonds are in vogue and overvalued, much as stocks were at the end of the 1990s, he said. After 30 favorable years of declining yields and rising prices, the best case for bonds over the next couple of decades is a return of "zero" after inflation "” and more likely a negative outcome, Siegel predicted.
If interest rates climb in future years, as is likely from today's very low levels, the prices of existing bonds with lower rates will fall. The impact may be felt more keenly by holders of bond mutual funds and exchange-traded funds than by investors who have bought individual bonds. The latter have the option to collect their bonds' full face value at maturity, while bond funds don't mature.
The latest stock-market bull has lasted longer than others. MarketWatch columnist Mark Hulbert says it might have run its course. Interview with Laura Mandaro. Photo: Getty Images.
"We're in the very mature stages of the secular bull market in bonds," said David Rosenberg, chief economist and strategist at Toronto-based investment firm Gluskin Sheff + Associates Inc. "I'm not bearish on fixed income, but when the five-year [Treasury] note is below 1% you know the game is not over, but it's close to being over."
Stock prices, in contrast, don't appear inflated. At the end of 2011, the Standard & Poor's 500-stock index traded at just under 13 times estimated 2012 earnings "” cheaper than its 17.5 average price/earnings ratio since the end of World War II, according to S&P Capital IQ. Compare that with March 1999, when the S&P 500 traded at 33.5 times earnings.
It's those kinds of valuation comparisons that lead experts to see room for stocks to move higher "” if only by a little, at first. But the goal for most investors currently seems to be staying ahead of inflation, not hitting home runs. And for many experts, stocks still fit that bill better than bonds.
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Jonathan Burton is the investing editor for MarketWatch and covers investing strategies and mutual fund-related news from San Francisco. He also writes the... Expand
Jonathan Burton is the investing editor for MarketWatch and covers investing strategies and mutual fund-related news from San Francisco. He also writes the "Life Savings" column. Previously he held contributing editor positions at Bloomberg Personal Finance, Mutual Funds and Individual Investor magazines, and was a reporter with the Far Eastern Economic Review and Investor's Business Daily. He is also the author of two books on investing. Collapse
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