June 06, 2022

Here’s a shocker most people probably don’t realize – bonds have outperformed stocks over the past two decades.

This is rare and unlikely to continue. I would argue the four-decade long bond bull market is done. Even worse is that some traditionally conservative investments, like U.S. Treasury bills and corporate bonds, are riskier than stocks right now, especially if interest rates continue to rise.

Of course, all this is counterintuitive. But let me explain.

Historically, stocks have outperformed bonds by a wide margin. Since 1928, stocks have delivered average annual returns of 10.9%. In that same time frame, Treasury bills with a duration of a decade or less produced average annual returns of 4.9%. Clearly stocks win.

But, in a more limited view of just the last 20 years, bonds have outperformed stocks.

Treasury bills that matured in 10 years or less delivered average annual returns of 8.3%. Conversely, the S&P 500 produced average annual returns of just 5.4% over the same period.

Remember, we’ve seen a historic decline in interest rates since about 1981. Back then, 10-year Treasury yields were near 16%, while in 2020 they plunged to near 0%:

Also keep in mind that bond prices and yields have an inverse relationship. That is, prices rise as yields decrease. So, with such a big overall yield decline, it’s really no surprise that stock returns couldn’t keep up.

But don’t expect it to continue unless the Federal Reserve drops interest rates into negative territory, which I don’t expect. We can likely expect stocks to go back to producing superior returns over bonds in the years ahead.

What’s the takeaway? Nobody knows the future, so hedge your bets with a diversified investment portfolio.

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