Morningstar Advisor - October/November 2009 - 28
Gray Matters Exhibit 4: Bulked Up on Yield Over the past 40 years, bonds got nearly all of its return from income that topped 7%. 10% 8 6 4 2 IA SBBI S&P 500 TR USD IA SBBI US IT Govt TR USD BarCap US Agg Bonds Index* IA SBBI US LT Govt TR USD Capital Gain 5.76 0.77 7.18 0.35 8.03 0.74 7.62 Conclusion Income Return Bonds not only have outperformed stocks by a large margin over the past year because of the financial crisis, but they also roughly matched stocks over the past 40 years. Will bonds continue to outperform? Upon closer examination, we show that stock returns over the past 40 years were virtually in line with the long-term historical average. On the other hand, bond returns were not only much higher than their historical averages, but also higher than their current yields. This high bond return is due to higher interest rates in the 1970s and a subsequent declining interest-rate environment. This scenario for bonds is very unlikely to repeat in the future, given today’s low-interest rate environment. Investors hoping that bonds will outperform in the coming years will likely be disappointed. Stocks tend to outperform bonds over time but are much more risky, even over longer periods. Bonds can outperform stocks over a long period, but investors need almost perfect timing to get in and out of the market to realize such returns. We believe the right strategy is to follow a disciplined asset-allocation policy that considers the return and risk trade-offs by taking advantage of the diversification benefits between stocks and bonds over time. As Warren Buffett wrote in his 2009 annual shareholder letter: “When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.” K Roger G. Ibbotson is chairman and CIO of Zebra Capital. He is also professor in practice at Yale School of Management and the founder, former chairman, and current advisor to Ibbotson Associates, a Morningstar, Inc. company. Peng Chen, Ph.D., CFA, is president of Ibbotson Associates. 3.43 Data July 1969–June 2009. Source: Ibbotson. *BarCap/LB US Aggregate Bond Index only goes back to January 1976. Exhibit 5: Yielding Less Today, bond yields are much lower. Asset Class July 1969 June 2009 Change IA SBBI US LT Government Yield USD BarCap/LB US Agg Bond Yield USD IA SBBI US IT Government Yield USD Source: Ibbotson. *BarCap/LB US Aggregate Bond Index only goes back to January 1976. 6.21 7.92* 6.93 4.30 3.88 2.51 –1.91 –4.04 –4.42 First, given the current low-yield environment, it would be almost impossible for bonds to generate the same amount of capital gains as they did in the past. In fact, a reasonable estimate might be that there will be no more capital gains going forward, since yields may be at least as likely to rise as to fall. If there were no future fall in yields, all of the return would have to come from the coupon return. in capital gains per year on average, they will likely beat bonds. Stocks’ capital gains can be decomposed into nominal earnings growth and changes in the P/E ratio. Historically, U.S. long-term nominal earnings growth has been roughly 5%, which is comparable to the nominal GDP growth. We will assume the market valuation level (operating P/E of S&P 500) will stay the same over the next 40 years. That means the total returns for bond investments would likely be between 3% to 4%. For stocks, the annualized dividend yield from January to July 2009 for the S&P 500 was 2.59%. If stocks produce more than 2% We would then have an equity return of around 7%. Even if we forecasted a decline in the valuation level, the 10-year average P/E level would need to fall from just about 20 to below five to get equity returns around 3%. 28 Morningstar Advisor October/November 2009
Morningstar Advisor - October/November 2009
Table of Contents for the Digital Edition of Morningstar Advisor - October/November 2009
Morningstar Advisor - October/November 2009
Contents
New on MorningstarAdvisor.com
Letter from the Editor
Contributors
How Do You Use Behavioral Finance in Your Practice?
Investing in the Moment
Investment Briefs
How the Best Large-Cap Managers Rise Above the Rest
Don’t Give Up on Stocks Just Yet
Makeup of the Mind
A Top-Down Approach
In Practice: Patterns of Investor Irrationality
A Call for Nudges
The Furious Comeback of Emerging Markets
Junk-Bond Pioneer
Four Picks for the Present
Consumer Staples Hold Up in the Kitchen
Familiarity Can Breed Bad Investment Decisions
Leave the ‘Junk Rally’ Behind and Look for Quality at a Reasonable Price
Mutual Fund Analyst Picks
50 Most Popular Equity ETFs
Undervalued Stocks
New at Morningstar
Meet the New Boss, Same (School) as the Old Boss
Morningstar Advisor - October/November 2009 - Morningstar Advisor - October/November 2009
Morningstar Advisor - October/November 2009 - Cover2
Morningstar Advisor - October/November 2009 - 1
Morningstar Advisor - October/November 2009 - 2
Morningstar Advisor - October/November 2009 - Contents
Morningstar Advisor - October/November 2009 - 4
Morningstar Advisor - October/November 2009 - 5
Morningstar Advisor - October/November 2009 - New on MorningstarAdvisor.com
Morningstar Advisor - October/November 2009 - 7
Morningstar Advisor - October/November 2009 - 8
Morningstar Advisor - October/November 2009 - Letter from the Editor
Morningstar Advisor - October/November 2009 - Contributors
Morningstar Advisor - October/November 2009 - 11
Morningstar Advisor - October/November 2009 - How Do You Use Behavioral Finance in Your Practice?
Morningstar Advisor - October/November 2009 - 13
Morningstar Advisor - October/November 2009 - 14
Morningstar Advisor - October/November 2009 - Investing in the Moment
Morningstar Advisor - October/November 2009 - 16
Morningstar Advisor - October/November 2009 - 17
Morningstar Advisor - October/November 2009 - 18
Morningstar Advisor - October/November 2009 - Investment Briefs
Morningstar Advisor - October/November 2009 - 20
Morningstar Advisor - October/November 2009 - 21
Morningstar Advisor - October/November 2009 - How the Best Large-Cap Managers Rise Above the Rest
Morningstar Advisor - October/November 2009 - 23
Morningstar Advisor - October/November 2009 - 24
Morningstar Advisor - October/November 2009 - 25
Morningstar Advisor - October/November 2009 - 26
Morningstar Advisor - October/November 2009 - Don’t Give Up on Stocks Just Yet
Morningstar Advisor - October/November 2009 - 28
Morningstar Advisor - October/November 2009 - 29
Morningstar Advisor - October/November 2009 - Makeup of the Mind
Morningstar Advisor - October/November 2009 - 31
Morningstar Advisor - October/November 2009 - A Top-Down Approach
Morningstar Advisor - October/November 2009 - 33
Morningstar Advisor - October/November 2009 - 34
Morningstar Advisor - October/November 2009 - 35
Morningstar Advisor - October/November 2009 - 36
Morningstar Advisor - October/November 2009 - 37
Morningstar Advisor - October/November 2009 - 38
Morningstar Advisor - October/November 2009 - 39
Morningstar Advisor - October/November 2009 - In Practice: Patterns of Investor Irrationality
Morningstar Advisor - October/November 2009 - 41
Morningstar Advisor - October/November 2009 - 42
Morningstar Advisor - October/November 2009 - A Call for Nudges
Morningstar Advisor - October/November 2009 - 44
Morningstar Advisor - October/November 2009 - 45
Morningstar Advisor - October/November 2009 - 46
Morningstar Advisor - October/November 2009 - 47
Morningstar Advisor - October/November 2009 - The Furious Comeback of Emerging Markets
Morningstar Advisor - October/November 2009 - 49
Morningstar Advisor - October/November 2009 - 50
Morningstar Advisor - October/November 2009 - 51
Morningstar Advisor - October/November 2009 - 52
Morningstar Advisor - October/November 2009 - 53
Morningstar Advisor - October/November 2009 - 54
Morningstar Advisor - October/November 2009 - Junk-Bond Pioneer
Morningstar Advisor - October/November 2009 - 56
Morningstar Advisor - October/November 2009 - 57
Morningstar Advisor - October/November 2009 - Four Picks for the Present
Morningstar Advisor - October/November 2009 - 59
Morningstar Advisor - October/November 2009 - 60
Morningstar Advisor - October/November 2009 - Consumer Staples Hold Up in the Kitchen
Morningstar Advisor - October/November 2009 - 62
Morningstar Advisor - October/November 2009 - 63
Morningstar Advisor - October/November 2009 - Familiarity Can Breed Bad Investment Decisions
Morningstar Advisor - October/November 2009 - 65
Morningstar Advisor - October/November 2009 - Leave the ‘Junk Rally’ Behind and Look for Quality at a Reasonable Price
Morningstar Advisor - October/November 2009 - 67
Morningstar Advisor - October/November 2009 - Mutual Fund Analyst Picks
Morningstar Advisor - October/November 2009 - 69
Morningstar Advisor - October/November 2009 - 70
Morningstar Advisor - October/November 2009 - 71
Morningstar Advisor - October/November 2009 - 50 Most Popular Equity ETFs
Morningstar Advisor - October/November 2009 - 73
Morningstar Advisor - October/November 2009 - Undervalued Stocks
Morningstar Advisor - October/November 2009 - 75
Morningstar Advisor - October/November 2009 - 76
Morningstar Advisor - October/November 2009 - 77
Morningstar Advisor - October/November 2009 - 78
Morningstar Advisor - October/November 2009 - New at Morningstar
Morningstar Advisor - October/November 2009 - Meet the New Boss, Same (School) as the Old Boss
Morningstar Advisor - October/November 2009 - Cover3
Morningstar Advisor - October/November 2009 - Cover4
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