Stocks are typically compared to medium-duration bonds, which are more popular and frequently traded, such as the 10-year Treasury. However, though useful, there’s a duration mismatch in that analysis. Most stocks have a duration of a lot longer than the duration of a 10-year Treasury bond. Roughly speaking, a 10-year bond has a duration of about 7 years, whereas for a dividend-paying stock the duration can be 20+ years.
Also, performance analysis typically factors in the risk associated with an investment as well as its return. That generally favors bonds as stock prices can be more volatile than bonds. For example during negative economic events, stock prices can move a lot whereas bonds can be more stable. That’s another reason to favor bonds. However, the recent trend for stock buybacks complicates the analysis because as not all of a stock’s income is picked up by the dividend when buybacks are material.
The author of the paper referenced above suggests that the experience of Japan may be instructive here. In 1996 Japanese 10-year government bonds yielded a little over 2%, most felt that was very low at the time. However, since then, the stock market has been broadly flat in Japan whereas yield on bonds have continued to fall. Indeed, yields in the U.S. are now lower than Japan saw in the 1990s.
Nonetheless, though the analysis is novel and insightful it may not be a sufficient justification to pile into long-duration at these levels. Warren Buffett has eloquently summarized the issue. To paraphrase, if the Federal Reserve has an inflation target of 2%, then why would you buy bonds yielding less than that? You’re betting the Fed will fail to achieve their goal. Even looking at just the last decade of U.S.
It does appear the attractiveness of government bonds over recent history has been underappreciated by many. Especially when stocks are compared to fixed income investments of equivalent duration. However, it may be excessively optimistic to believe future decades will be as rosy. The recent strong rally in the gold price to all-time highs suggests some market participants agree.
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