Which Performed Best Over The Past 15 Years: Zeros/Munis Or Stocks?

Evidence of How Difficult It Is to Garner Excess Returns in the Stock Market

In January 1995, the Republicans took over Congress for the first time in, almost, forever. Quickly a form of gridlock took place that helped the stock market levitate. The R’s wouldn’t let President Clinton spend, and he wouldn’t let them cut taxes. So the cash budget balanced soon enough, capital gains taxes were cut, and the prior record of three consecutive years of 20%+ stock market gains gave way to five years- 1995-99 inclusive. And then the S&P 500 hit a new record late in 2000. It was an amazing run. Since January 1995, the U. S. economy has only been in recession for about 8 quarters out of the 65 completed quarters since then. This is a historically better than average performance. So one would think that stocks have been fine performers overall.

Here are the stats. Since 1995 the S&P 500 has risen from 470 to 1340 (approximate numbers). This is a compound annual return of 6.60%. Adding in dividends brings the annual return to about 9%.

If one invested in a low cost index fund to mirror the index, fund expenses would bring the total return lower. And of course, assuming the fund is not held in a tax-exempt vehicle, taxes on dividends and capital gains would have been taken.

Also at the beginning of 1995, 10-year Treasuries yielded 7.2%, and 30-year T-bonds yielded 7.7%. Given a typical discount, that suggests that high-grade muni bonds would have yielded about 7% for long-term bonds. So, munis would have been as good as stocks for taxable accounts from then until now.

For retirement accounts, where tax rules for the unrealized appreciation inherent in zero coupon bonds are not relevant, the total return from a zero coupon 30-year Treasury bond (non-callable) can be calculated as follows:

At an annual yield of 7.7%, the price for a $1000 face value bond would have been $108. In other words, $108 in 1995 would be promised to turn into $1000 in 2025, with no interest payments for all that time. Today, 16.4 years later, this bond would now be a 13.6 year zero coupon bond, which I am estimating would be trading around $620 to give a yield to maturity of something over 3.4%. Thus the bond would have risen from $108 to $620 in 16.4 years, which my interest rate calculator says is about an 11.2% per year annualized return. This return is from the starting interest rate of 7.7% enhanced by a decline in market interest rates, further enhanced by the upward slope of the yield curve.

In other words, a time period that began with the greatest 5-year surge in stock prices in the history of the United States (at least since the dawn of the 20th Century) has led to equal stock market performance to that of plain vanilla municipal bonds for taxable accounts and to significant underperformance to that of a plain vanilla zero coupon Treasury bond for tax-deferred accounts.

In my view, this example should “put paid” to the idea that most people should put most of their investment funds in the stock market all of the time.

Copyright (C) Long Lake LLC 2011


7 comments to Which Performed Best Over The Past 15 Years: Zeros/Munis Or Stocks?

  • Carl

    The sheep herder, Jeremy Siegal would like a word with you.

  • Keith Weiner

    Great article and great analysis DoctoRX.

    I would assume that all during that time, people debated when the “cyclical” rally in bonds would end. The reason they would cite for not putting a substantial chunk of one’s money into bonds is that when rates started going up one would take capital losses.

    Today while that debate rages on, it may not seem so crazy to say that it’s not a “cyclical” rally. Bonds will continue to rally (i.e. interest rates will continue to fall) until the crack-up boom.

    Today, I would ask how much more pain in Greece, Portugal, Ireland, Spain, and Italy will it take to drive EURUSD (currently $1.416) to 1 or below? How much higher does the interest rate in Spanish and Italian bonds need to creep before the 10-year UST trades below 2.5% (currently 3.152%)?

    And of course, QE feeds this monster. The “inflation” theory (they print more money, this causes prices to rise, and bond investors “demand” a higher rate to compensate them for the loss of purchasing power) is bunk.

    POMO and QE are designed to prop up asset prices. Until the crack-up boom when commodity prices in paper will go out of sight, this means bonds more than anything else. Commodities (except gold and silver) have to be consumed and higher prices brings on more supply while at the same time causes the bid to withdraw. Stocks have to actually produce a profit, i.e. a margin, and in this economic/tax/regulatory/litigation/FX/unemployment environment that is exceedingly hard.

    Go (US Federal Government) bonds! For now…

  • Carl- great comment!

    Keith- thanks for the thorough comment. I converted a good deal of personal capital into long T-bonds on Friday. Talk about a hated asset . . .

  • Keith Weiner

    Good call DoctoRX and good timing. My screen shows -1.14% on the 10-year interest rate (to 3.116). I see Fitch put Belgium–BELGIUM!!!–on negative outlook watch. Belgium is not one of the PIIGS, but apparently is in danger of getting sucked into the edges of the space-time-warp around the black hole…

  • dd

    Doc and Keith: so you guys would rather give the United States Treasury your money for say, 10 years, in return for 3% annually; versus finding someone competent in the stock market for 3x that yield? someone with a net cash position, who generates gobs of free cash, and whose business is geographically diversified? they are out there.

    your macro points are not lost on me, i just don’t see how they translate to this positioning.

    another point: in 1995 the 10-year yielded in the 7s, while the s&p 500′s yield (earnings + dividends) was in excess of that by roughly 1%, so call it, average over the year, mid 8s. here and now, the 10-year is in the 3s and you can get the s&p (earnings + dividends) for 9%. so the backdrop is different. and while i am dour on the our fiscal situation and the economy in general, it’s not like you’re buying largecap tech at 30x EPS on the outset of a recession, like in 2000-2001.

    • Keith Weiner

      dd, no I sure don’t want to give my money to the Treasury for 10 years. It’s all about a capital gain and out in a lot less time than that. This reminds me of an awesome post on iTulip a year or two ago. In the Insane Asylum Economy, things that would have no value circulate as if they were highly valuable: shanks, toilet paper, (cigarette) butts, etc. So it is with the world economy today under the Insane Asylum monetary system of irredeemable paper currency.

      I agree, hold your money in gold and silver. Speculate with beer money, not lunch money. Someone was telling me on Facebook a few days ago when the EURUSD blew up, he lost his rent money and was going to be evicted. That really saddened me, and should not happen.