One of the principal decisions investors have to make is how to allocate their assets between stocks and bonds. Although stocks generally provide a higher rate of return than bonds, stocks are also more volatile, and investors run the risk that when they need to take money out of their portfolio, stocks might be in a bear market, reducing the amount of money available to them. One of the indicators we look at to determine the optimal allocation between financial assets, is the relative returns between stocks and bonds, and in particular, the 10-year and 20-year rates of return for stocks and bonds. We have found these to be one of the most effective indicators for allocating assets. Five-year rates of return have too much noise in them to provide useful signals, and thirty-year rates are too stable to provide important signals on the relative returns on stocks and bonds. We use the return on the S&P 500 for stocks and the GFD’s index of returns on 10-year government bonds for bonds. As most investors know, stocks generally outperform bonds over time because equities are riskier than bonds and investors must be compensated for this risk with a higher rate of return. However, this is not always true. Occasionally, though rarely, bonds outperform stocks over a period of 10 or 20 years. This only happens once in a generation, and the Financial Crisis of 2008 created one of those rare events. As a result of the financial crisis, for the first time since the 1970s, stocks underperformed bonds over the previous 10 years, and for the first time since the 1940s, stocks underperformed bonds over the previous 20 years. Typically, investors look at the annual returns to stocks, bonds and bills and the volatility of returns to determine the level of risk they face in choosing between assets. In reality, investors don’t look at one-year time periods in making their long-term investment choices, but want to look at periods of ten, twenty or more years in order to prepare for their retirement. Without a long set of data, there is insufficient evidence to make informed decisions about how to allocate investment resources between different asset classes. Global Financial Data has over 150 years of history on the interaction between the 10-year and 20-year returns on stocks and bonds in the United States. This amount of data provides a more realistic view of the information investors need to make long-term investment decisions. The 10-year total returns to stocks and bonds are illustrated in the graph below with stocks represented by the blue line and bonds represented by the red line.
The graph illustrates that stocks generally outperform bonds over time, and that stock returns are more volatile than bond returns. What is more interesting than these well-known facts are the periodic, but rare, occasions when bonds outperform stocks over a ten-year period. The primary periods when stock returns fell below bond returns were in the 1880s and 1890s, the 1930s, the 1970s and the 2000s. Over the past 150 years, these have been once-in-a-generation events that are followed by periods of several decades in which stocks consistently outperform bonds, in some cases by wide margins.
Several important facts should be noted about this graph. In most cases, increases in the rate of return to stocks at the beginning of each cycle were accompanied by decreases in the rate of return to bonds, as was true from around 1900 to 1930 and from 1940 to 1970. This occurred when nominal interest rates were low at the beginning of a cycle. The period between 1980 and 2005 was different from the other periods because the cycle began when inflation rates, and thus nominal interest rates, were relatively high. Consequently, as inflation and nominal interest rates fell, these changes generated capital gains which increased the long-term return to fixed income investors. Once inflation fell to normal levels, the 10-year return on bonds began to fall. Yields on 10-year bonds have been declining consistently since 1981 which means that over the next few decades, the graph is more likely to look like the 1940s and 1950s than the 1980s. It should also be noted that the 10-year relative returns to stocks and bonds cross over several times before stocks begin to consistently outperform bonds for a period of 25 years or more. Although it is impossible to know the returns this graph will show over the next 30 years, stock returns will probably fluctuate dramatically over the rest of the decade, and during the next bear market, 10-year returns to stocks will temporarily fall below the returns to bonds before rebounding. Nevertheless, the 10-year returns to stocks and bonds have begun to show a divergence which is likely to continue in the future. Below is the graph for the relative 20-year returns on stocks and bonds over the past 150 years. As can be seen, there have only been three times in the past 150 years when bond returns exceeded stock returns over a 20-year period: at the bottom of the bear market in 1932, during 1949, and during the financial crisis in 2009 and 2010. Since long-term bond total returns probably will continue to decline, 20-year stock returns are unlikely to drop below 20-year bond returns again for decades. As is true of the 10-year graph, stock and bond returns are beginning to diverge. Although there is no guarantee financial markets will repeat their past performance, there are several possible implications of this once-in-a-lifetime signal from financial markets.
- Stocks should generally outperform bonds over the next 30 years because a new cycle in the relative rates of return began a year ago.
- When the current bull market runs into trouble sometime in the next few years, the relative 10-year return on stocks will temporarily fall below the return on bonds, but will soon recover.
- The 10-year rate of return on bonds is in long-term decline, and is likely to continue. Because, unlike in the 1980s, inflation rates are not excessively high, during the initial phase of this cycle, long-term return to bonds should decline not only in relative terms, but in absolute terms as well, before reversing about half-way through the cycle.
- At the height of the cycle, stocks will have returned 15%-20% over the previous ten years. This peak should be reached sometime in the 2020s.
- This cycle reinforces the conclusions I made in my paper, Are You Ready for the Bubble of the 2020s which discusses the convergence of long-term factors which favor a strong bull market in the 2020s. The stock market could fluctuate for the rest of the decade before breaking into a secular bull market in the 2020s.
One possible conclusion to draw from these graphs is that long-term investors should consider allocating more of their assets toward stocks, and take advantage of market downturns during the next few years to reallocate money from bonds into stocks. Of course, past performance is no guarantee of future returns, but as anyone who looks at these graphs should realize, events such as these only happen once in a generation.
A previous blogged discussed the founding and dissolution of the First Bank of the United States (BUS) which existed from 1791 to 1811. After the First BUS recharter was defeated, the United States suffered defeat in the War of 1812, and suffered from a lack of fiscal order and an unregulated currency. As industrial and commercial interests expanded after the War of 1812, politicians advocated for the creation of a second Bank of the United States to promote the economy. After the war, there was sufficient support to overcome the opposition to the first BUS. Opponents of a second BUS had seen its charter as not only a threat to the Jeffersonian agrarianism and state sovereignty, but to slavery since, as John Taylor of South Carolina put it, “if Congress could incorporate a bank, it might emancipate a slave.” The bank’s constitutionality had been established in 1819 in McCulloch v. Maryland, a landmark decision in constitutional history, but many still felt the establishment of a bank by the Federal government was unconstitutional. The Bank of the United States would be a depository for collected taxes, make short-term loans to the government, and could serve as a holding site for incoming and outgoing money. The main goal of the bank would to promote commercial and private interests by making sound loans to the private sector. The second BUS charter was signed into law on April 10, 1816 by President Madison. The second BUS was modeled on the first with the government owning 20% of the $35 million in equity, divided into 350,000 shares of $100 each. The bank had 4000 investors of which 1000 were Europeans, though the bulk of the shares were owned by a few hundred wealthy Americans. The second BUS had 25 branch offices in addition to its main office in Philadelphia. After the BUS was established, southern and western branches issued credit to fund expansion. This led to a financial bubble that burst in the Panic of 1819 leading to sharp declines in property prices, much as happened in 2008 when the most recent bank-induced bubble led to a financial crash. The public was unhappy about the prolonged recession that resulted from the BUS-induced Panic of 1819. Nicholas Biddle took over the BUS in 1823, and switched to a sound money policy. At that point in time, state-chartered banks could issue their own currency, but when their currency was deposited at the BUS, the bank would demand gold or silver from the issuing bank, thus controlling and limiting the issuance of currency by state banks. Because the number of banks in the United States grew from 31 in 1801 to 788 in 1837, state-chartered banks began to oppose the BUS because it limited their ability to issue currency and make profits. Shares in the Second Bank of the United States were the most liquid and most secure of all shares listed on US exchanges. The bank paid steady dividends to its shareholders, increasing the dividend from $5 in 1819 to $7 by 1834. Since the US government succeeded in paying off all of its outstanding bonds by 1835, the stock of the Bank of the United States was not only the largest issue on the stock exchange, but it was also the safest since it was backed by the United States Government, or so it seemed.
Andrew Jackson had received the largest number of votes, the largest number of electoral votes and carried the most states in 1824, but failed to gain a majority. The House of Representatives elected John Quincy Adams as President instead. When Jackson was elected in 1828, he felt rancor toward his opponents for keeping him from being chosen President in 1824. Jackson was a populist, and even though the Bank was popular because the economy was growing as a result of its sound-money policies, Jackson opposed the BUS as unconstitutional, corrupt and a danger to American liberties. In Jackson’s mind, the BUS was at the center of the class warfare of the 1830s which pitted “farmers, mechanics and laborers” against the “rich and powerful,” in words that seem reminiscent of Occupy Wall Street’s opposition to the 1%.
Jackson’s opposition to the BUS led to the “Bank War” between Jackson and Biddle over the rechartering of the Second BUS. The recharter of the Second BUS became the focal point of the 1832 election. Pro-bank forces tried to get a vote on the charter prior to the 1832 election to discourage a Presidential veto, but anti-bank forces delayed the vote until after the election when Jackson vetoed the recharter, and which Congress failed to override.
One of Jackson’s first actions after re-election was to remove all government deposits from the Bank of the United States and spread them out among state-chartered banks, crippling the second BUS. Biddle counterattacked by contracting bank credit, but this led to a financial downturn which only added to opposition against the BUS. Business leaders in American financial centers became convinced that Biddle’s war on Jackson was more destructive than Jackson’s war on the Bank. When the Second BUS’s charter expired in 1836, the bank rechartered as a Pennsylvania private corporation. In 1839, the bank suspended payments, and it went into liquidation in 1841. As was true of the first BUS, the bank was born of politics and died of politics. Andrew Jackson won the bank war, and the BUS charter lapsed in 1836. At one point during the Bank War, Jackson had offered to charter a new bank if it were publically owned, and it did not compete with state-chartered banks by issuing commercial loans. Although Jackson’s version of a Central Bank never came into existence, when the Federal Reserve was chartered in 1913, Jackson had his way at last because the Federal Reserve is 100% owned by the government, does not compete with commercial banks, and to avoid the political battles over rechartering, the charter for the Federal Reserve is perpetual.
Today the battles are over who is appointed Federal Reserve chairperson, not over whether the Federal Reserve should be rechartered. The advocates of hard money and soft money continue to battle over interest rates, quantitative easing, the Federal deficit, funding the government and the other subjects related to the availability of credit. The Bank War was not just part of the 1832 Presidential election, but it is part of every election and almost every battle involving the economy today, and in the future.
The Northern Pacific Railway was a transcontinental railroad that operated across the northern tier of the western United States from Minnesota to the Pacific Coast. The goal was to connect the Great Lakes with the Puget Sound. Along with the Southern Pacific and the Union Pacific (originally the Central Pacific, but renamed during the Civil War), it was to be the northernmost of three transcontinental railroads.
The President, Directors and Company, of the Bank of the United States, or the First Bank of the United States, as it is more commonly known, was chartered for a term of twenty years, by the United States Congress on February 25, 1791. The bank was part of Alexander Hamilton’s plan for stabilizing and improving the nation’s credit by establishing a central bank, a mint, and introducing excise taxes.
The Bank of the United States was to have $10 million in capital, of which $2 million would be subscribed by the government. The $8 million in shares sold to the public (20,000 shares at $400) were quickly purchased and the price of the stock initially rose to $600. Of the first $8 million in shares that were sold, one quarter had to be paid in gold or silver. The rest could be paid in bonds, scrip, etc. Shares sold for $400, and to understand how much money this was by today’s standard, the per capita income in the United States in 1791 was only $50 (vs. over $50,000 today), so one share of stock cost the equivalent of $400,000 in today’s dollars, making Berkshire Hathaway Class A stock cheap by comparison.
Hamilton modeled the Bank of the United States on the Bank of England. The bank could be a depository for collected taxes, make short-term loans to the government, and could serve as a holding site for incoming and outgoing money. Nevertheless, Hamilton saw the main goal of the bank as a way of promoting commercial and private interests by making sound loans to the private sector, and most of its activities were commercial, not public.
The Bank of the United States was a privately-owned bank and was the only Federal Bank, though states could also charter banks. The bank had a 20-year charter; foreigners could be stockholders (and owned about three-fourths of the stock), but could not vote; and the Secretary of the Treasury had the right to inspect the bank’s books as often as once a week.
There were a couple ways, however, in which the First Bank of the United States differed significantly from the Federal Reserve Bank. The Bank of the United States could not buy government bonds, and the bank could neither issue notes nor incur debts beyond its actual capitalization. Alexander Hamilton would have been a strong opponent of Bernanke’s quantitative easing, and if Bernanke had studied the First Bank of the United States rather than the Great Depression, he might not be Fed Chairman today.
The same battles that exist today between tight-money and easy-money factions existed when the Bank of the United States was established and will always exist. The “moneyed interests” of the northern, commercial businesses generally favored the bank while the southern, agricultural groups opposed it. The reason for this is quite clear. Since farmers had to borrow money to fund their crops and people in the southern and western United States needed capital to buy land and establish new communities, they wanted interest rates as low as possible. Lenders of money wanted to keep interest rates higher and provide sound money. Since the wealthy had suffered from the depreciation of the Continental Dollar, which lost 99.9% of its value during the Revolutionary War, lenders wanted to avoid another debasing of the currency. Moreover, the Bank of the United States was the largest bank in the country, so state banks were naturally opposed to this competition.
When the Bank’s charter came up for renewal in 1811, the Democrats, who opposed the bank, were in control of Congress, while the Federalists, who had set up the bank, were not. The vote to renew the charter failed by one vote in both the House (65-64) and in the Senate where the vote was deadlocked at 17 and Vice-President Clinton cast the deciding vote against the renewal of the charter. The Bank of the United States was born of politics and died of politics. Votes along party lines are nothing new in Congress.
This battle between lenders and borrowers continued for the rest of the century. It occurred again when the Second Bank of the United States was established in 1817, and when William Jennings Bryan ran for President three times at the end of the nineteenth century and made his “Cross of Gold” speech. Today, in the twenty-first century, the same battle lines are drawn between easy-money advocates in favor of quantitative easing, and tight-money opponents who believe these policies will lead to another bubble and financial crash. No doubt, two hundred years from now, the same battle lines will be drawn.
For shareholders, the Bank of the United States was a good investment. While U.S. Government bonds paid 6% interest, Bank of the United States stock paid an 8% dividend. When the Bank’s charter was not renewed, the bank liquidated and paid off investors in full. Stephen Girard purchased most of the bank’s stock as well as the building in Philadelphia where the Bank had its headquarters. Philadelphia and not New York was the financial capital of the United States at that time, and Philadelphia was also the capital of the United States from 1790 to 1800 before the capital was moved to Washington, D.C.
Global Financial Data not only has price data for the First Bank of the United States, but a complete record of dividend payments for the bank as well. The price of the stock fluctuated between $400 and $600, and the bank paid $634 in dividends on the original $400 investment.
Although Ben Bernanke wouldn’t admit it, Alexander Hamilton probably would have voted against Bernanke’s quantitative easing, but since the easy-money interests were able to prevent the charters of both Banks of the United States from being renewed, that should come as no surprise.
