Stock Picking in a Bond-Friendly Environment
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In Goodbye TINA, Hello BAAA, I made the case that investors should expect better total returns from bonds than stocks over the next 10 years. To be clear, investors should not ditch stocks and hold only bonds. But if I am correct and bonds generally outperform stocks, picking the right stocks instead of the most popular ones may be more rewarding than investors have grown accustomed.
The overwhelming popularity of passive investment strategies has dramatically diminished the value of stock picking. Instead of actively picking stocks offering the most value, unique fundamental traits, or the right industry, passive investors have been rewarded for picking the top dozen or so stocks in the most popular equity ETFs. As we enter a period of potentially low expected stock returns, passive investing may be less appealing, and once again, the art of stock picking may be of value.
In this article, I look back to other periods when bonds outperformed stocks. This analysis allows us to assess specific stock traits and specific industries that over- and underperformed in prior bonds are an alternative (BAAA) eras.
The BAAA era is coming
The graph below shows the cyclicality of monthly 10-year excess total returns for stocks versus bonds.
My methodology to calculate total returns assumed that we buy and hold the S&P 500 for 10 years and a 10-year UST bond until maturity. As such, there are no price gains or losses on the bond.