Bonds Beat Stocks in 2011 -- But Don't Expect That to Repeat

Bonds beat stocks
Bonds beat stocks

The unthinkable happened in 2011. For the first time in several decades, the 30-year annualized returns of Treasury bonds surpassed the dividend adjusted gains of the S&P 500.

According to Morningstar, Treasuries scored an annualized return of 11.03% a year over the past 30 years, squeaking past the 10.98% annualized return of the S&P 500 in that time.

The rare event defies logic. We've been told that stocks outperform fixed-income investments. We've been told that risk and return are related. If you want greater returns, you have to take bigger chances by choosing stocks over bonds. However, a combination of the "lost decade" for stocks and plunging interest rates driving up the price of long-term fixed-income investments have turned the two asset classes into passing ships.

Take a picture if you want -- because this won't last.

Equities remain the investment of choice for those seeking the greatest long-term returns. Let's go over a few reasons why.

1. Stocks Have Rarely Been This Cheap

The beauty of stocks as investments is that their fundamentals never stand still.

Microsoft (MSFT) has been a disappointment on this side of the millennium. The stock has gone from a split-adjusted price of $45.53 a share at the end of 1999 -- when the dot-com bubble was inflating and the theory was that folks would be upgrading their PCs to avoid any Y2K hang-ups -- to $25.96 a dozen years later.

Microsoft isn't growing as quickly as it used to back in its prime, but the world's largest software company is in fact still growing. Sinking share prices and increasing profitability provide a stark contrast in valuations. The same Microsoft that was trading for more than 50 times earnings at the peak of the dot-com bubble is now fetching just 10 times what analysts are targeting for this fiscal year that ends in June.

Mr. Softy is just one example. Even some of the stocks that have bucked the malaise and appreciated considerably during the "lost decade" for equity prices are trading at historically low multiples. Apple (AAPL) has been a big winner in recent years, but the class act of Cupertino is being exchanged these days for a mere 12 times this fiscal year's projected profitability.

2. Bonds Have Rarely Been This Expensive

A bond's price and its interest rates are inversely related. If you buy a new 30-year bond with a 2% yield and interest rates drop, the principal value of the bond will increase. If you ever flip on CNBC and see bond prices climbing on bad news and shrinking on good news, it's actually the result of interest rates heading lower when the market's worried or rising when the economy's doing well and inflation fears begin to creep in.

Sponsored Links

The Fed has been trying to keep rates near historic lows, hoping that businesses borrow to stimulate the economy and potential homebuyers take out cheap mortgages to put an end to the real estate meltdown.

Obviously these low rates aren't sustainable in the near term.

It's not as if you can lock in that historical 11.03% rate, either. The current yield on 30-year Treasury bonds is hovering around 3%. Hold it until it matures in 30 years, and that's exactly what your annualized return will be. However, if you have to sell it in the future -- and odds are that rates will be at least a little higher -- you're going to have to sell it for less.

3. Stocks Are the Best Investment Class

Gold had a good run over the past couple of years, and everyone has a rich uncle who scored big by playing commodities, but stocks remain the asset class of choice for investors willing to commit to the research to smoke out the better companies.

Buy a bond, and the interest payments are a steady trickle. Buy a growing company and either capital appreciation or dividend hikes can reward your choice.

Retailer REIT Federal Realty (FRT) has come through with 44 consecutive years of declaring higher dividends. Disbursements-processing giant Automatic Data Processing (ADP) has come through with 37 straight years of meatier payouts. Your Treasury bond can't do that.

Sure, there will be times when stocks lose money, often during interminable bearish stretches. They will never provide the stability that settling for 30 years today at 3% will deliver. However, all of the trends that have boosted bond returns over equities are on the verge of reversing.

Longtime Motley Fool contributor Rick Munarriz does not own shares in any of the stocks in this article. The Motley Fool owns shares of Microsoft and Apple. Motley Fool newsletter services have recommended buying shares of Automatic Data Processing, Apple, and Microsoft. Motley Fool newsletter services have recommended creating bull call spread positions in Microsoft and Apple.

Get info on stocks mentioned in this article: