Stocks or Bonds - The Eternal Debate!

Jarrod is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

One of the aspects that makes investing so interesting is the enormous impact psychology has on results (and profits) people achieve (or don’t).  What makes this so fascinating is there is an absolute plethora of information and research out there available for investors to utilize to educate themselves, yet so few do.

One such instance where the effect of psychology has impeded investor returns in the eternal battle of stocks vs. bonds. In 2012 stocks, at least according the press of popular opinion had nothing but bearish head winds blow against them. There were debt ceiling issues, the threat of credit rating downgrades, a slowing economy, double dip recession, the list was endless.

Equally, bonds were supported (according to the media) by favorable tail winds and the grossly over used ‘safety of Treasuries’ mantra.

Yet for all the issues stocks has going against them, they actually outperformed bonds. Below is the relative graph of stocks as measured by the ETF SPY relative to Bonds as measured by the ETF TLT bond fund.

<img src="/media/images/user_16314/article-2-graph-spy-tlt_large.JPG" />

For the calendar year of 2012, TLT returned just 1.47%. I guess a return to be happy with if you believed deflation was going scourge the markets and collapse the prices of assets the world over. SPY however returned a respectable 11.69%.

Using SPY and TLT as proxies, stocks outperformed bonds on an absolute basis by some 10%. On a relative basis stocks were leaps and bounds ahead of bonds.

What is the lesson we can take away from this?

Be wary of blindly following the crowd and the popular opinion. Just because there a multitude of people and press publications espousing reasons for why a market will / should do something does not mean it necessarily will. In fact the stronger the consensus, the more likely that the exact opposite will happen!

Think about it for a minute. If everyone is bearish on stocks then who is left to sell? By definition if everyone (in a generalized sense) is bearish then they will have sold their stocks. So if they have sold out of stocks, who is left to sell and drive the price further down? The answer? Very few. Because of this the path of least resistance is up.

At the start of 2012 very few people would have predicted much less been willing to invest in the view that SPY would return nearly 12% for the year and dramatically outperform bonds. Yet this is exactly what happened.

Looking forward I pose the question, ‘is this bullish run coming to an end or is it just getting going?’ My guess – it still has a significant way to run and hence there is a good deal more upside in stocks. When the press of popular opinion is singing the praises of the stock market and focusing on all the great tail winds then I will be thinking this Bull Run is on its last legs. Until then I am backing equities

There are number of big cap stocks I like that when bundled together give investors a good, broad diverse exposure to the overall market. Stocks such as Bank of America (NYSE: BAC) – in 2012 returned 100% (hmmm… bet not many people realized that!) Even with this retirement crunching return, Bank of America is only trading at a Forward PE of 9.3, with a PEG ratio of just 0.65. Whilst Bank of America’s dividend yield is small at just 0.3%, it is useful to keep in mind the payout ratio is a very conservative 16%.

Is Bank of America likely to return 100% in 2013? Who knows, but I would guess that it has significant more upside potential than bonds which that are trading at more or less 30 year highs.

If you feel the banks are too unpredictable for you, have you considered Pfizer (NYSE: PFE)? With a healthy return of 14% in 2012, Pfizer might well offer considerably better risk adjusted returns and value for long term investors than bonds. With a PE of 11, Pfizer is by no means expensive and has a strong pipeline of reliable earnings to support its respectable 3.5% dividend. Pfizer also offers something that bonds do not – the potential for dramatic upside should PFE discover a new miracle drug. Should an event like this occur, stock price appreciation of twenty plus percent is not without precedent.

How about Coca-Cola (NYSE: KO) Coke has proved itself to be an excellent manager of investor capital. With consistent and long term earnings growth and a very impressive return on equity of 27%, Coca-Cola has proved itself to be stellar investment performer. Add to this excellent capital management, a respectable dividend of 2.7%, from a payout ratio of 52%. Investing in KO could be argued offers investors a level of safety sought from bonds yet with greater yield as well as better upside growth potential.

Bank of America, Pfizer and Coca-Cola are major players in industries that are essential and thus very unlikely to become obsolete anytime soon. This adds a level of dependability to their earnings potential. 

JarrodBailey1 is long via LEAP Options and Long Dated Warrants in Bank of America and Pfizer. The Motley Fool recommends Coca-Cola. The Motley Fool owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

Fool Blogger Jarrod Bailey has long positions via LEAP Options and Long Dated Warrants in BAC and PFE. All opinions in this article are my own and do not necessarily reflect the views of the Motley Fool. Nothing in this blog is to be taken as investment advice or recommendations. Always seek professional advice that takes into account your personal circumstances, objectives, goals, needs and risk profile before investing in any stock or investment product. I am not responsible for any investment decisions you make

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