Bonds Are Primed for a Better 2023, but How Much Better?

[mahatmakanejeeves]

Bonds are due to improve, for sure, in 2023—it just might not be the comeback that investors will want

wsj.com
Bonds Are Primed for a Better 2023, but How Much Better?
Investors might believe that after a horrible 2022, bonds can’t help but have a positive return next year. Not so fast.

Link to tweet

[progree]

1. Vanguard's forecast for next 10 years: U.S. equities: 5.7%, Bonds: 4.6%

annual average return

Vanguard economic and market outlook for 2023: Global summary, Vanguard, 11/23/22

10 year annualized return: U.S. (equity) markets: 4.7%-6.7% (midpoint 5.7%)

Bonds-4.1%-5.1% (midpoint: 4.6%)

There are also forecasts of GDP growth and inflation etc. in 2023

https://investor.vanguard.com/investor-resources-education/news/vanguard-economic-and-market-outlook-for-2023-global-summary

VCMM = Vanguard Capital Markets Model

No idea on what the longevity of the bonds they are using in this.

Unfortunately, I didn't find the great detail rationale for the forecasts that they had last year, December 16, 2021 --
https://advisors.vanguard.com/insights/article/series/vanguardeconomicandmarketoutlook

Maybe the 2023 one will come out in mid-December?

[PoindexterOglethorpe]

2. WHY are they suggesting a return significantly less than

the usual average return for ten years? For a very long time now, ten year returns average at least 10%/year.

What catastrophe are they forecasting to lead to such relatively low returns?

[progree]

3. It's explained in the links I gave - stocks are way overvalued relative to historic levels in a

Last edited Thu Dec 8, 2022, 07:55 AM - Edit history (3)

number of metrics. The December 2021 Vanguard one goes into a deep dive. The Mark Hulbert links go into some other valuation metrics.

Myself, I think these valuations have gotten way high because of TINA (There Is No Alternative), namely that the competitor to stocks -- bonds and other fixed income investments -- have been having such lousy interest rates that people have gravitated more and more towards stocks over the past 2 decades.

However, at least for now, bond yields are somewhat better now than they have been (they were over 4% for intermediate treasuries recently for example, though slipping back to more like 3.7%). So sky-high CAPE ratios or total market valuation to GDP ratios are not as justified as they were, when intermediate Treasuries were yielding 0.5-2.0%.

That said, interest rates are still at historically quite low levels, and moving downwards. So it's not like people are excitedly reallocating to bonds and CDs because of eye-popping yields or anything like that.

They are not forecasting "a catastrophe", but rather an eventual "regression to the mean" -- a return to more historic levels in these valuation metrics.

Here's a couple more links --

Stock market gains depend on profit margins rising, and they’re already impossibly high, Mark Hulbert, MarketWatch, 4/2/22

https://www.msn.com/en-us/money/markets/stock-market-gains-depend-on-profit-margins-rising-and-they-re-already-impossibly-high/ar-AAVKWct?ocid=msedgdhp&pc=U531&cvid=96857cbf9874431699370cb07c64e1fa

More recently, 11/25/22
https://www.msn.com/en-us/money/savingandinvesting/stocks-will-lag-behind-bonds-and-even-decline-over-the-next-10-years-says-a-valuation-model-based-on-eight-indicators/ar-AA14xuqD?ocid=msedgntp&cvid=5024582484dd4feab45483d036f6cbab

[progree]

4. Not for every 10 year period -- they vary quite a lot from one 10 year period to another

Last edited Sun Dec 11, 2022, 02:00 AM - Edit history (6)

For a very long time now, ten year returns average at least 10%/year.

Here's one of the S&P 500 index that I made in March 2020 when it went down during the pandemic. You can see there are some pretty long flat spots followed by a burst of high growth. Yes, it's missing dividends. But adding in dividends isn't going to turn flat periods into 10%/year periods.



One can calculate 10 year returns (including dividends) from this (it's just year-end values, so not a lot of granularity)
https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html

For more granularity, one can use VFINX, the Vanguard S&P 500 index fund. It's a real fund with real expenses, so nobody in the Economy Group can blather about how yeah, but that's before the "House" takes its share. This is after expenses, what an actual investor would have realized.

https://finance.yahoo.com/quote/VFINX/history?p=VFINX
Use the "adjusted close" column to get total retun including distributions. (The "close" column is just the price).

Edited to add Rolling 10 year returns of the "US Stocks Portfolio ETF"

10 year annualized rolling returns over time: (also n year for various values of n):
http://www.lazyportfolioetf.com/allocation/us-stocks-rolling-returns/
Scroll down the page about 2/3 of the way down to get to the 10 year graph, labelled
"Annualized Rolling Returns - 10 Years (120 months)"

Speaking of just 1949 onward, for example, the graph shows the 10 year rolling average varying from -4.86% in Feb 2009 (meaning Mar 1999- Feb 2009) to +20.20% in December 1999 (meaning January 1990 - December 1999).

Edited to add: that -4.86% doesn't look too bad as the worst case in 73 years. But it's an average annual return over 10 years, that corresponds to a cumulative 39.2% loss over that decade, meaning a $100,000 nest egg turned into a $60,800 one: (100%-4.86% = 95.14% = 0.9514;  , 0.9514^10 = 0.608,   1-.608=0.392).

The latest 10 year average is December 2012 to November 2022: 10.99%

As for what this thing is --
http://www.lazyportfolioetf.com/allocation/us-stocks/

It says: "The US Stocks Portfolio can be implemented with the following ETFs: 100% VTI - Vanguard Total Stock Market

but it has data going all the way back to 1871!

[PoindexterOglethorpe]

5. Thank you for that information.

However, I'm still not convinced.

That said, I do not buy and sell individual stocks. I have an investment guy who has done very well for me. He does not buy and sell individual stocks, but has put me in a number of very good mutual funds. When he wants to make any kind of major change he calls me first. Since his day job is to pay attention to all the nuances and details, and to keep me a happy camper, I always tell him fine with the changes.

I know there are people here who totally scorn investment advisors. They seem to be the very ones who panic every time there's any kind of downturn in the market because they are buying and selling regularly.

I will say this, that despite my confidence in the average of 10% yearly returns over time, when I check how long my money should last given my current withdrawal rate (I use an on-line calculator), I change its default assumption of 8% yearly returns to 6%. Basically what Vanguard is predicting.

[progree]

6. I don't do individual stocks either. I own just one, a large utility, and would have a big

capital gain if I sold it, so I've left it in place. It's been doing a little bit better than the S&P 500 in the time I've had it, so I'm content. Everything else is in a mutual fund or ETF.

Most active fund managers can't beat their benchmark indexes, so I'm not even going to try. I'm glad you / your finance guy don't either. (Admission: I do own some active funds -- meaning ones that try to do better than their benchmarks).

I know there are people here who totally scorn investment advisors. They seem to be the very ones who panic every time there's any kind of downturn in the market because they are buying and selling regularly.

I remember it being controversial here when I said I did the opposite -- moved 14% of my portfolio from fixed income to equities after the S&P 500 had dropped more than 20%. So far it's been a good move but I realize that can easily change in a week (it was underwater for a while in mid-October). From a long run perspective, it's called buying stocks on sale.