Montreal, Canada

According to money-manager, Rob Arnott of Research Affiliates in California, bonds have outpaced stocks over the long-term and with far less risk.

Mr. Arnott recently contributed an article to the Journal of Indexes refuting the long held notion that stocks always beat bonds.

From 1969 through February 2009 investors in 20-year U.S. Treasury bonds would have outpaced the returns generated by the S&P 500 Index. This assumes the investor rolled over his bond holdings into the nearest 20-year instrument in 1989 and reinvested the income.

According to Research Affiliates, the bull market that followed WW II in stocks gave investors a false sense of asset allocation that equities always beat bonds. That long held view dispelled in the Panic of 2008 with equities posting their worst calendar year loss since 1937; longer term returns generated by stock indexes were also severely damaged. By March 2009, the S&P 500 Index was at the same level compared to 1997. The same is true for the MSCI World Index of major economy stock markets.

During the period from 1949 to 1965, the S&P 500 Index gained 16.3% per annum while bonds rose just 1.9% per year. By 1966, a bear market had begun, morphing into a secular bear market that resulted in a flat stock market until 1982; adjusted for inflation, which began in earnest in the late 1960s, stocks actually posted a cumulative loss from 1966 to 1982. Bonds also fared poorly.

Over the past 200 years, stocks have outpaced bonds by 2.5% per annum – but half of that advantage comes from the 1949 to 1965 period, says Arnott.

Looking ahead, stocks might outpace bonds over the next decade because interest rates are so low and eventually will have to rise. That might not happen any time soon because credit intermediation in the consumer sector remains badly impaired while the economy is struggling to regain over five million lost jobs.

Still, over the next few years rates must rise as the United States is forced to attract deficit-financing and the deluge of bond supply; bonds, which have enjoyed a secular bull market rally since 1982 when interest rates peaked north of 15% are probably among the worst investments from now until the next global economic crash.

And stocks? They might outpace bonds over the next few years but it’s a relative story. It’s hard to make a bullish case for equities because domestic consumption won’t return to the pre-2007 glory days any time soon. Without a vibrant and credit-hungry U.S. consumer who will buy the world’s manufactured products? Earnings won’t sustain a long-term recovery – at least not beyond the next few quarters as this current growth recovery runs out of gas.

Stocks and Treasury bonds are therefore a bad bet over the next several years. Both will provide poor inflation-adjusted returns once deflation is put to bed by massive central bank monetary expansion, a falling dollar and global stagflation.