Bonds Are King, but Stocks May Be the Better Move


From piling into stocks as the dot-com bubble peaked at the end of the 1990s to losing all confidence in the spring of 2009 ahead of a roaring rebound, individual investor sentiment is famous for frequently being out of sync with the way the market moves.

Even though retail investors are finally starting to get more bullish on stocks following recent strong economic news, most are still bearish. That has meant big business for bond funds, which investors have flooded seeking safe returns. The problem with bonds, however, is that right now they offer very low returns.

For now, the number of investors content with paltry returns is shocking. While $42 billion has left U.S. stock mutual funds since the market started to rebound in April 2009, a staggering $450 billion has flowed into bond funds over the same period. Some analysts see this as evidence of widespread investor apathy.

This apathy may come at a high price for investors in the form of passed up returns. While piling into ultra-safe assets like U.S. government bonds despite rock bottom yields has led to plenty of talk about a bubble, the returns investors are willing to forego for the simple comfort of putting their money into any jar labeled "bonds" is striking.

IBM: Stocks or Bonds?

Just take the case of a blue chip company like IBM (IBM), which turned heads last month when it was able to issue three-year bonds at a mere 1% interest rate. The stunningly low rate speaks in part to the well-founded confidence that credit markets have about the company's financial position over the intermediate term.

But investors still shy away from the company's stock despite the far more generous returns to be had there. For the current year, shares are on track to earn $11.29 a share, bringing the earnings yield to 8.9% for the $127.58 stock. The company pays a dividend $2.60 making for a yield of 2%. And analysts expect earnings to grow to $12.36 per share next year.

While investors can't get enough of IBM's bonds, they seem to be avoiding far more attractive IBM shares like the plague.

Some of this bunker mentality is understandable given the nerve-racking stock market of late. Getting a return on their money seems too ambitious and many investors are opting instead for instruments that would simply preserve it.

Still, those willing to stomach the volatility may be looking at juicy returns thanks to the unduly pessimistic backdrop. Strong manufacturing data from around the world along with better than expected unemployment news in the U.S., for example, recently painted a much more bullish picture of the economy than the near record ranks of bearish individual investors would have guessed.

More complacent investors still sitting in bonds should realize they might be paying a very high price in terms of passed up returns for the perceived safety.