A widely cited study found that long-term bonds beat the performance of the stock market for the 30 years ended Sept. 30, 2011. This was the first time that bonds were the better long-term investment since Abraham Lincoln was president.
The key to the big bond market gains in the mid-1800s was the same as it was in the past 30 years.
Inflation expectations were higher than actual inflation. In 1831, inflation spiked after a 15-year deflation. Expecting the new inflation trend to continue, interest rates moved higher. Instead, deflation returned for most of the 1800s, except for a brief period of very high inflation during the Civil War.
Inflation was also high in 1981, when the 30-year bull market in bonds began. Inflation is now at about 3 percent a year and most consumers expect it to hold steady near that rate.
The latest data from the Thomson Reuters/University of Michigan consumer sentiment survey shows that annual inflation is expected to average 2.7 percent during the next 10 years.
At that level, interest rates on the 10-year Treasury note should move close to 5 percent, and the price of bonds would fall more than 40 percent if that happens.
According to standard forecasts, stocks should return at least 6 percent a year, on average, with that level of inflation.
Even low inflation will decimate the dollar over time.
Buying power will be reduced by almost 25 percent with low inflation, even more at higher levels of inflation. Investors need to consider the growth potential of stocks for the next thirty years rather than wishing they had been invested in bonds for the past 30 years.
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