Stocks vs. Bonds

"The widely accepted notion of a reliable 5% equity risk premium is a myth," contends Robert Arnott, chairman of money manager Research Affiliates, in a paper to be published this spring in The Journal of Indexes.

"We've had 30 to 40 years of building this cult of equities, where if your time horizon is long enough, it doesn't matter what you pay for stocks," Arnott tells Barron's. "That's dangerous."

It's especially dangerous for investors, from individuals to endowment to pension funds, who were counting on equities to outrun fixed-income holdings and deliver supersized returns.

From 1802 to 2008, [Rob] Arnott says, stocks outpaced bonds by 2.5 percentage points annually. But that superior showing can be deceiving because there were long stretches in which stocks underperformed, most recently in the 41-year period that ended on Feb. 28. True, the Standard & Poor's 500 lagged behind the 20-year Treasury bond by a mere two basis points (two hundredths of a percentage point) a year in this lengthy span, but that's enough to render it a substandard performer.

Bonds also beat stocks from 1803 to 1871, and from 1929 to 1949. But there were other multi-decade spans, such as the period from 1932 to 2000, when "stocks beat bonds reasonably relentlessly," Arnott says.

On balance, he writes, stocks have had "long periods of disappointment, interrupted by some wonderful gains."

Stocks hold appeal at currently depressed levels, Arnott contends, noting that the S&P looks a lot more attractive today, with a dividend yield around 3.4%, than it did when its yield was much lower -- and its price/earnings multiple much loftier.

--- Barrons, 3.28.09