Tuesday, July 14, 2009

stocks underperform bonds

As of June 30, U.S. stocks have underperformed long-term Treasury bonds for the past five, 10, 15, 20 and 25 years.

Still, brokers and financial planners keep reminding us, there's almost never been a 30-year period since 1802 when stocks have underperformed bonds.

These true believers rely on the gospel of "Stocks for the Long Run," the book by finance professor Jeremy Siegel of the Wharton School at the University of Pennsylvania that was first published in 1994.

Using data assembled by other scholars, Prof. Siegel extended the history of U.S. stock returns all the way back to 1802. He came to two conclusions that became articles of faith to millions of investors: Ever since Thomas Jefferson was in the White House, stocks have generated a "remarkably constant" average return of nearly 7% a year after inflation. (Adding inflation at 3% yields the commonly cited 10% annual stock return.) And, declared Prof. Siegel, "the risks of holding stocks decrease over time."

There is just one problem with tracing stock performance all the way back to 1802: It isn't really valid.

* * *

[7/15/09] Jeremy Siegel responds (sort of).

The short answer is that stocks are still the best long-term investments. As bad as the past decade has been, there have been other 10-year periods during which stocks have recorded even bigger losses. Yet over periods of 20 years or longer, stocks have never lost money, even after inflation. Including the latest bear market, stock returns have averaged 7.8% per year over the past 20 years and 11% annually over the past 30.

After periods of sluggish returns, stocks tend to regain their oomph. Stock returns over the past five and 10 years have fallen to the bottom quartile when measured against all five- and 10-year periods since 1871. But history shows that after reaching such a low, stocks' average return for the next five years has been almost 9.5% annually after inflation.

Furthermore, once stocks have plunged 50% from their highs, which they have done during the current bear market, investors have always been rewarded with winners over the next five years -- and that includes the Depression decade of the 1930s. In December 1930, stocks were 50% off their highs of September 1929. Yet, over the next five years -- when the economy was experiencing the greatest contraction in its history -- investors were rewarded with an annual return of 7% after inflation.

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