Why Everyone Hates Equities And Loves Bonds

Tyler Durden's picture

Day after day we are brain-washed with the mantra of equity dividend yields being greater than treasury yields implies 'cheapness' or "who wants a 2% return from treasuries?". While we have tried again and again to put this dead-end of apples-to-unicorns valuation to bed, SocGen has an excellent treatise on the subject that should make all but the most ardent Bill Miller fan comprehend the ultimate risk-reward trade-off.

At its simplest level, comparing a risky instrument with an inherently risky cash-flow stream (equities and dividends) to a risk-free (at least from a get-back-your-money basis) should be a red flag for any valuation approach - no matter how ingrained it feels. While describing risk is always prone to complexity and argument, the chart below shows that based on current levels equities (SPY) are 32% (orange line) more volatile (risky) than TSYs (TLT). At the same time, the relative yield advantage (black line) is 10.8% higher in stock dividend yields vs TSYs - so a 3:1 risk-to-reward ratio for the switch from bonds to equities.  

Chart: Bloomberg

Of course capital appreciation 'potential' is the main argument against this simple approach and that is where SocGen's excellent article comes in.

Sub 2% bond yields offer miserable nominal returns, but equities always carry the risk of massive drawdown. Major losses on bonds typically stem from inflation eroding returns, not major price declines. Nominal bond drawdown has rarely exceeded 10% on a 5-year rolling basis.


Let's put the relative risk attraction of bonds and equity returns into context. The five year maximum drawdown of US Treasuries and US equities on a nominal return basis is shown above. The point here is to show just how much more risky equities are versus bonds when it comes to losing money. Equity investors have seen several periods of substantial drawdown, whilst on a nominal return basis, which is the only thing that matters when marking to market, bond drawdown has been much more limited.


And so to longer-term investing and the benefits of buy-and-hold:

How regularly each asset inflicts pain on the holder is shown below. Here we make the assumption that you buy and hold each asset for a five-year period. We then ask the question, how many times, if investing on a monthly basis, since 1950, would you have taken a 20%, 30%, 40% or 50% drawdown?



They succinctly summarize the asset allocation decision as follows:

The bond investor could have bought bonds 90% of the months since 1950 and avoided having a 20% drawdown or more, whilst the equity investor could have only invested in 40% of months to avoid such losses. Extreme drawdown of 40% or more, even on a real basis, is almost unheard of in the bond market, but seen 17% of the time in equities. Yes bonds at sub 2% offer miserable returns, but equities will always offer a higher probability of major losses and until we have an investor base that is able to take such losses, low yields and a systematic preference for bonds is likely to be with us for a while. Risk capital will also be in short supply - if you have it, better use it wisely.


As Boomers head into an uncertain retirement, we wonder whether this type of 'realistic' analysis will trickle-down to investor expectations and 401(k)s as the triangle of risk-reward-regret becomes more and more prescient every day.


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Quinvarius's picture

Or maybe it is just the fact that the Fed is pushing prices bond up as a policy tool and it is easy cheddar...for the moment.

flacon's picture

Is it immoral to own slaves (bonds) even if they are stupid sheep? Would you own the produce of your fellow citizen and neighbour (not in a free market capitalist dividend way, but as a mandatory TAXATION for them)? Or is finance just a-moral - is a BOND is just another financial "vehicle" for you to make profit?


I would argue that BONDS are inherently IMMORAL. We want FREEDOM FROM BONDS. So all of you, sell your bonds and set the people FREE! No true libertarian owns GOVERNMENT bonds. 


And before I was "saved" I used to work for Merrill Lynch. Helping to enslave all of you. "But I was just doing my job". 

Mactheknife's picture

We'll be sure and pass that along to the ten thousand boomers who are now retiring every DAY.  My guess is they're probably not going to see it that way.

spiral_eyes's picture

The thing this article misses?

Bond prices are massively overvalued. 

The global economic system has treated the notion that you get your money back from bonds as a precept.

You don't. Sometimes you have to take a haircut. Sometimes you face default.

Once that house of cards has fallen, investors will flock to the only true havens:

The metals. 

flacon's picture

the notion that you get your money back from bonds as a precept.


If you have a printer I am 110% sure that you will ALWAYS get your currency back as promised. 




The ONLY advantage of paper money over gold is that you can PRINT IT! Therefore on Wednesday we will see more PRINTING. That is the ONLY - THE ONE AND ONLY advantage that paper has over gold. Don't you think they would be asses not to use their ONLY advantage?


spiral_eyes's picture

Printing is a haircut.

And I'm not entirely sure Bernanke will print on Wednesday. QE3 is coming, maybe this year, maybe next, but Wen Jiabao wouldn't have been so nice in public if Bernanke was going to do it immediately.

Cutting rates to zero on excess reserves is more likely, in my view.

And that might unleash a can of hyperinflationary worms (then again, it might not — if it gets banks lending to productive ventures then it might even help).

flacon's picture

if it gets banks lending to productive ventures then it might even help


It will be the death knell of PRODUCTIVE ventures. And that's what they want, so maybe you will be right. 


jedimarkus's picture

The REAL precious metals: brass, lead, copper....

flacon's picture

My guess is they're probably not going to see it that way.


Well the truth has a funny way of always having the last comment. But you are right I am sure they will blame the wrong crowd. 

floyd084's picture

If all of us are to sell bonds, who do you suspect will be buying them? 

IQ 145's picture

Why everyone does not hate equities and love bonds; Equities rally and you get to book the profits; Bonds don't. There;s absolutely no way to lose money on the stock market except to sit there and watch it go down. You have to be in charge; not your broker; never mind the "don't sell now, the market will go back up" demand that your invenstment work for you; buy bottoms; buy pessimism; and if it's not going up; sell the bitch. immediately. Everyone I ever met who told me stories about losing significant amounts of money on the stock market had weeks to react; during which the losses were trivial; off the top of their booked profits. In every case; every case; they folded and listened to the broker; or worse yet; they had a mutual fund. Do it yourself and demand performance; no performance; dump it. The market'll be around next month.

piceridu's picture

What a great theory...tell that to the old folks walking into the banks and being accosted by the Wealth Advisor".

My parents were financially illiterate Italian imigrants with 3rd grade educations. 

When my mom and dad walked into their bank many years ago, they were often approached by the bank’s financial planner, or the “wealth" advisor who would tell them they were wasting money just keeping it into a saving account and that he had a better idea for their money. 

Well my parents believed that he had to know better…after all, he was the wealth advisor for goodness sake. 

Well it turned out that he was a good financial planner…but unfortunately, he wasn’t good for my parent's or his customer’s wealth, but for his own and that of his employer.

Little did my parent’s know that he was just putting them into financial products that were rewarding the FP and the bank?  He was selling lemons and churning fees to unsuspecting bank customers without any knowledge or regard for their circumstances. Did he ever call my parents when these financial bombs were losing value and had negative returns? Did he ever tell them to get out and suggest something better that might benefit them?  When finally confronted, he would just tow the company line and would say what almost every broker/salesman in the country would say: “You’re in it for the long term”. Don’t worry it will come back”. 

Virtually all modern TBTF banks are financial engineering centers producing financial service product created for one simple reason: to separate you from your money. 

They unleash endless streams of financial jargon together with intimidating mathematical formulae that quickly deters the overwhelming majority of people from any attempt to understand them. But the complexity of our financial system is just a smoke screen to mask one of most paralyzing social structures humans have ever devised. 

By making investment vehicles so complicated, ambiguous, and back loaded with fees, you are hoodwinked to believe you "need" these “financial saviors” to sort through it for you.

Not everyone has 145 IQ

baby_BLYTHE's picture

Irrational Exuberance if I ever saw it

Corn1945's picture

Buying bonds at record low interest rates. Out of the frying pan and into the fire.

ZeroPower's picture

Also, many people just dont understand bonds enough to be able to say "fuck this equity bullshit". 

IQ 145's picture

Very true, Canadian Womens ! But don't let's forget they don't understand equities either !  The article as posted is so flawed as to be laughable. At the present moment the American Banking system is absolutely awash in demand and short term money; everyone and their brother has "gone to cash"; this is one reason why it's so easy for the S&P and the DOW to rally, right now; As for the Bonds; well there's always only one question; what time is it? And if the answer is; it's high price time; which it certainly is; then the only right answer is; No Thanks!  There's a painful awakening in store for the Bond Fund buyers; we just don't know the hour or the day; but we know it's coming.

PaperBugsBurn's picture

Man, I gotta say this: most of you people complain about the sheople and the banksters but man are you guys dense. S&P was acting on behalf of a bankster faction which wanted the dollar cut down to its actual economic size. They where straightened out (JPM,GS etc being sued, CEO of S&P fired Blankfein lawyering up) and now they are out to destroy the euro. This is a well advertised move with even the lame ass Tyler Durden going along with it (nothing posted on Chinese dumping treasurys but plenty of yellow journalism on Europe).

But what astounds me is how few of you get it...effing amazing. You're like monkeys at the zoo; only able to focus on 5 second soundbites. 

I come here to get different viewpoints but it's like there's nothing there...maybe all that Matrix MSM conditioning has dumbed you down.


Id fight Gandhi's picture

No one is forcing you to put up with our comments and ideas.

PaperBugsBurn's picture

Believe me, I only skim through the comments which have become so droll and uninformed as to resemble the MSM.

Oh, and if I hurt your lttle feelings:

FUCK YOU, loser

CosmicBuddha's picture

Rather than criticise others why not tell us something useful. I am fascinated to learn what you have to offer us.

SamuelMaverick's picture

paperasswipe, please continue to be a useful idiot and post your pathetic trite.  We need a replacement for Harrywanger and Leo.  Or better yet, go back to marketwatch or yahoo finance and dazzle them with your superior knowledge. 

Id fight Gandhi's picture

Respect. Disagree with other ideas, don't bash people and call them names.

Tyler Durden's picture

China has been "dumping" bonds for the past 2 years. In the meantime, their actual holdings have risen close to all time highs - link... just because you care about the facts

PaperBugsBurn's picture

The Davos statement was new. And yes, they are buying mines (hard assets) like mad here in South America and Africa.

The shift away from the dollar to an SDR or a gold standard is a planned one. The wealth of the world versus the husk of the US economy is a no-brainer fir the banksters to choose from.

mayhem_korner's picture

The shift away from the dollar to an SDR or a gold standard is a planned one. The wealth of the world versus the husk of the US economy is a no-brainer fir the banksters to choose from.

Explain.  "Wealth" is not an attractive thing for banksters - they want a population of debtors, not depositors.  So what's the attraction?  Are you saying that those interested in centralization/globalization are bent on accumulation of assets to back an emergent, asset-backed currency? 

Just tryin' to understand what you're saying...

mayhem_korner's picture

Yes bonds at sub 2% offer miserable returns, but equities will always offer a higher probability of major losses and until we have an investor base that is able to take such losses, low yields and a systematic preference for bonds is likely to be with us for a while.

This looks like the fine print of some AIG CDO pitch.

Risk is grossly mispriced in both bonds and equities now, so we can't make statements about "major losses" without qualifying investment objective and tenor.  Diversification across equities is almost non-existent - they are viewed as a collection rather than individualized claims on distinct going concerns.  Bottom line: way too much of an oversimplification.

Disclosure: < 20% equities, < 25% bonds, balance PMs, commodities, cash and hard assets

FreedomGuy's picture

The point that is also missed is that a company can always change or even eliminate it's dividend. I was holding that crap stock from Pfizer and their Obama loving CEO, Kindler. I even bought more as their dividend approached 7%. Then they cut the dividend to purchase Wyeth. At least a bond is a contract. A dividend is not. That's part of the bond premium. 1980's investment advice won't work now.

Having said that we are in a total political economy. Everything...bonds, stocks, commodities all depend on the latest government and central bank interventions. It's litle different from playing Vegas.

We're all screwed except for the government insiders.

PaperBugsBurn's picture

Get a clue

From sources inside the non-governmental organization (NGO) community, we have been informed that George Soros's "themed revolution" operations are now on the streets in America. Hoping to steer and influence popular outrage over President Obama's and the GOP's bailout of Wall Street billionaires and the steady whittling away of government services, including Social Security, Medicare, and the Postal Service, the Soros-funded "democracy" operations are working hand-in-glove with the CIA-influenced National Endowment for Democracy (NED) and its Republican and Democratic subsidiaries, as well as Democratic Party political operatives. Also funding the "democracy" operations is the CIA-funded U.S. Agency for International Development (USAID).

The Soros operatives, well-experienced from similar operations in eastern Europe and the Arab world, are behind the scenes sponsoring and steering, for their own purposes, "day of rage"-style street demonstrations



mayhem_korner's picture

To what end, Dr. Insight?  Folks want their mugs in the NYT, or is there a purpose to the day of rage stuff?

zen0's picture

Like the "Day of Rage" on Wall Street? It was more like "Day of Consternation" or "Day of Wandering Aimlessly Mumbling Lame Slogans".


"From sources inside the NGO community...."  Is that like the "tenting community"?


You come in here like you are William Munny and all you got in your shotgun is smurfballs.


"Themed revolution" operations in America are as ubiquitous as mortar-board losers advertising local restaurants.


I smell G-man.

zen0's picture

Oh. I see now. It is an adspot spamalot.


Step your game up.

Restcase's picture

These are left wing Falangist websites. "Not that that's a bad thing."

Tell more about the planned destruction of the Euro and who is involved.

candyman's picture

Thats it, PBB just gave himself away...nothing new from PBB, we have discussed these topics in great detail and more for months on end. Sounds like PBB must have had a long talk with his father and is quite excited about his new knowledge. Time to move on.

nmewn's picture

Munch munch munch.

"but equities will always offer a higher probability of major losses"


rocker's picture

I think it will go something like this. When TPTB allow a real correction in American markets that equals a economy that prices in "We are Worse than Japan now" the bond market can rightfully correct.  As long as they hold up equities waiting for the next sucker to buy a overpriced stock that the HFTs want to sell. Treasuries will go up.

After they allow the correction one can buy stocks and sell off bonds. But a flash crash is not a correction until we see capitulation. We all know what it looks like. There will be no 52 week high stocks going buy and Cramer will say this is not the time to buy stocks.

Afterall, Cramer told us that Bear Stearns was a buy at $69.00 just before it went to $2.00   Now Cramer says the banks are a screaming buying opportunity as the banking system is locking up again with Europe's and France's banking problems just beginning to shine. Contagion. Yes. Believe it.

Then there is one other problem with the markets. We are contracting, not growing. The market pays for growth, not a recession that never ended.

greenewable's picture

Check the long-term (70 year) chart of dividend yields vs AAA and BBB Corporate Bonds.  Looks a lot different.  Also looks like we are headed into the mid to late 1930's when dividend yields blew out past BBB bond yields....

New_Meat's picture

I'm kinda' new to all of this finance stuff, but, well, 70 year "historical" "precedent" seems rather unimportant.

But I'm still at the second big drop in '32 or so.  Haven't shattered the pumch bowl yet.

- Ned

treemagnet's picture

I blew all my risk capital on pm's.

Eireann go Brach's picture

Is Jersey Shore on yet?

Ricky Bobby's picture

Screw that I a can't wait for dancing with the stars - Go Chaz Go

caerus's picture

dividend yield is imo no reason to purchase equities in the current environment...i wouldn't hold most stocks a month much less the amount of time required to get any return from dividend payments...once the big break comes, if it is severe enough, then i will hold equities...until then they're all just trades

BandGap's picture

Abso-freakin-lutely, caerus.  This is all bent towards longer term holdings, something requiring insanity in the market.  What a ride.

max2205's picture

T Bond bubble..... That aside everything trades in a range for a while. Just watch the step up or down adjustment

tempo's picture

According to some experts, the German elections are not signaling opposition to direct funding/loans to the PIIGS but opposition to allowing the ECB (France?) making the loans or issuing EURO bonds with Germany losing control. Makes sense, but then can the EU survive?

chump666's picture

This is what I think will happen.  Greece will vote themselves out of the EU, Germany will push them out.  Italy next, then Spain...Either that or Germany goes.  It's such a mess.