Forget Stocks. This Year, Bonds Have Had More Fun

It's no secret U.S. stock investors have suffered through roller-coaster volatility this year for no real return, while fixed-income investors have been having a ball. The longest-dated Treasury mutual funds have returned nearly 20%. Equities, meanwhile, have done zilch.

Even short-term Treasury debt has been a better bet than anything benchmarked to the three major market averages -- and the yields on 3- and 6-month T-bills are negative.

Take the S&P 500 ($INX) as the benchmark for the U.S. stock market. It has generated a return this year of negative 0.07%, according to Morningstar. (That's price performance plus dividends though Sept. 8.)

Now have a look at the Barclays U.S. Aggregate Float Adjusted bond index, a broad benchmark for U.S. bond market performance. It has generated a total return of 7.42%. That's been great news for investors in the retail-friendly Vanguard Total Bond Market Index (VBMFX) which tracks the index: It has returned a healthy 7.28% so far.

No wonder more than $30 billion flew out of U.S. equity mutual funds from January to July, according to the Investment Company Institute -- and more than $185 billion gushed into bond funds. Bond prices have gone bonkers.

Is the Bull Market in Bonds a Bubble?

It's also little wonder that some pundits see a bubble forming in long-term Treasury debt. The longest-dated Treasurys -- those with maturities of greater than 20 years -- have generated a return of nearly 20% this year, according to Barclays Capital Indices. The yield on the 30-year Treasury stands at about 3.8%, folks: The remainder of that boffo return came from price appreciation. (Recall that bond prices and yields move in opposite directions.)

Meanwhile, Treasurys with maturities of seven to 10 years have thrown investors a 13% return so far this year. That would be a heck of a return on an equity portfolio in an "average" year for the stock market, even if inflation were running at 3%. Junk bonds (see "U.S. Corporate High Yield" in the chart below) seem positively boring by comparison, having returned just a bit more than 9%.

Plenty of bears, such as David Rosenberg, chief economist at Canada's Gluskin Sheff, say talk of a Treasury bubble is nonsense. But just to be safe, it's best to focus on bonds with significantly shorter durations, says Oliver Pursche, co-portfolio manager of the GMG Defensive Beta Fund (MPDAX).

"Bond bubbles are not like stock bubbles or real estate bubbles" Pursche tells DailyFinance. "They don't tend to burst with volatility or violence. They tend to deflate slowly, and it's a slow painful death."

That's why Pursche is focused on bonds with maturities of fewer than seven years. (Treasurys coming due in three to five years have generated an enviable return of more than 8% this year, by the way.)

To see how various classes of debt have performed in 2010 (and whether your bond fund manager is keeping up with his or her benchmark), see the chart below.