2/21/2012 7:54 PM ET|
Investing lessons from the 1950s
The current climate is unlike anything most investors have seen before. But there are similarities to the period after World War II.
Break out the poodle skirts and crank up the Perry Como.
It's often said that investors these days are navigating uncharted territory. The world's major economies are swamped by massive amounts of debt, the Federal Reserve has essentially locked interest rates at zero and the outlook for corporate profits is increasingly cloudy.
Many investors are paralyzed in this environment, which is unlike anything they have seen in their adult lives. As a result, they're hunkering down in cash and super-safe government bonds. However, as is often the case, investors can look to the past and find potential guideposts for building a portfolio for today's markets.
In this case, history suggests that stocks with higher dividends could be in for a long period of healthy returns. Looking at the broad stock market, history also suggests stocks in general could struggle compared with government bonds as long as rates are capped by the Fed, which is contrary to the conventional wisdom today. But for the longer term, stocks are a better bet than bonds.
For their history lesson, investors should set their wayback machines to the period beginning in the late 1940s. It was a time when bond-market interest rates didn't float freely as they usually do, but instead were capped by the government at low levels to help the country manage the enormous debts accumulated during World War II.
Economists have a gloomy sounding term for when bond-market rates are explicitly or implicitly capped below the rate of inflation. It's called "financial repression."
Today, the Fed is engaged in a similar push. It's been buying trillions of dollars of bonds in an effort to keep market rates low to help repair the economy. The Fed has said it expects to keep interest rates near zero through late 2014.
Barry Knapp, head of U.S. equity portfolio strategy at Barclays Capital, has studied this period and the period after the Fed loosened the reins on rates in 1951.
Low interest rates
For the post-war period in which the Fed capped rates, as is the case today, investors earned meager yields. At the time, the Fed was keeping rates just north of 1%, a level which was below inflation.
It's worth noting, though, that by keeping rates from rising, the Fed also kept bond prices from falling. "The yield cap meant prices couldn't go anywhere," says Knapp.
Meanwhile, stock prices struggled during that period. Conventional wisdom in the markets these days is that extremely low government-bond yields force investors to move their money to riskier investments, such as stocks. But, says Knapp, "that's not what happens until (bond) prices return to normal."
As was the case in 2011, during the late 1940s stocks generally suffered from a decline in price-to-earnings ratios, which reflected less willingness of investors to pay for future growth of corporate earnings. In 1948, government bonds posted returns 1.1 percentage points greater than stock returns when dividends are included, according to Barclays.
Bonds were for the most part a better investment than stocks until the Fed lifted the cap on rates in 1951. That year the tide reversed and stocks outperformed bonds by 25 percentage points, according to Barclays. Aside from recession years, that trend of outperformance by stocks continued over the course of the decade. (It was 1954, incidentally, when the Dow Jones Industrial Average ($INDU)finally regained its pre-1929-crash level.)
The downside to investing in bonds when yields are capped became clear when the caps were lifted: Rising yields pushed down prices on existing bonds.
"Investors can't just invest in Treasurys and expect a return in excess of inflation," says Jason Trennert, chief investment strategist at Strategas Research Partners.
In early 1951, the real yield on long-term U.S. Treasurys -- which measures the yield minus inflation -- was around negative 6.5%, according to Strategas.
Continued on the next page. Stocks and funds mentioned: Automatic Data Processing (ADP, news), Thomson Reuters (TRI, news), Vanguard Dividend Growth (VDIGX), Franklin Rising Dividends A (FRDPX) and Matthews Asia Dividend Investor (MAPIX).
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The Glass-Steagall Act of 1933 was in full force back in the 1950's.
Bretton Woods Agreement (Gold Exchange Standard) was in full force during the 1950's.
That's why were in a economic mess right now. These two rules provided financial stability....Now, anything and everything goes! The Wild, Wild West of the 1880's. Very few rules/regulations on accountability and responsibility. Now the bank robbers are CEO's of large financial institutions who collect 8 figure bonuses every year and give huge campaign contributions to the members of the US Congress to maintain the current and corrupt system.
"Past performance is no indicator of future performance".
Have a good day and lets hope the market continues to rise.
Break out the poodle skirts and crank up the Perry ComoI was thinking more like the Big Bopper and the peppermint twist. But as far as the bond market and similarities .. it is worth a review when taxes were a hair bit higher, too.
The world's major economies are swamped by massive amounts of debt. The Federal Reserve has essentially locked interest rates at zero for year to come. If you are a saver of money in a money market account, CD or even cash under you bed, you are in real trouble. There is nothing you can do to make money short of working at job until you drop dead. Savers are out of luck now and long into the future. The FED doesn't care about you. You can just drop dead as for as the FED is concerned. Spend a little money on yourself and family. No one can take that away from you once it is done.
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