Stock and Bond Drawdowns – Historical Perspective

I thought this was a nice bit of perspective from CitiGroup analysts regarding the historical drawdowns between stocks and bonds.  Proper portfolio contruction is all about understanding how different asset classes operate relative to one another.  And while the past doesn’t perfectly rhyme with the future, it does provide us with a better general understanding:

“Bitter experience means that the bond refugees are now very aware of the Warren Buffett classic: “The first rule of investing is don’t lose money; the second rule of investing is don’t forget rule number one”.

Perhaps this is what makes them such skittish participants in the equity market. Of course they can lose money in the bond market, but the equity market has always had the capacity to lose them so much more. Figure 6 shows the top ten global equity and US treasury draw-downs in each year since 1970.

There have been some ugly experiences for investors in the US treasury market over this period. For example, in 1980 10-year yields rose from 9% to 14%. Investors lost 16% of their capital. But this worst annual drawdown in treasuries wouldn’t even make the top ten for global equities. Equity investors lost 48% of their money in the 2008 drop and 33% in the 2002 correction. Even last year’s drawdown (-11% loss), which was seen as relatively mild, would rank as the fifth worst in 40 years of US treasury market performance.

Overall, the worst ten drawdowns in global equities average 27%. That’s way more than the 11% seen in US treasuries. Even in notorious years such as the bond selloff in 1994, losses for treasury investors were unexceptional (-12%) compared with those regularly experienced in global equity markets.”

Source: Citi


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. More importantly is that Treasuries often rally when the stock market is crashing off of deflationary recession fears. When you extend your maturity out to 30 years that relationship can seriously smooth out a portfolio. Sprinkle in some gold to protect you from declining real interest rates and you are getting close to something robust.

  2. I’d forgotten about those two nasty years, 2001 and 2002. Back-to-back negative 30%+ in a row. Yikes.

  3. You might want to look back a little further. 1915-1920=-51% and the drwadown that started in 1940 that lasted for 50 years.
    See Dimson Marsh Staunton “fear of falling” They conclude that “bond market drawdowns have been larger and/or longer than for equities”

  4. Jason – It may not be a coincidence that the market evaluations listed are since 1970. I would think it is fair to say that the way the US sovereign bond markets work since that time (with several changes between 1970 and today) is quite different from the way it worked before that time.

    Now, in fairness, I do not think the Citi analysis looks at real returns (i.e. net of inflation). That might make the bond drawdowns look a bit worse, but it would do the same for the equity drawdowns.

  5. If you look at total returns of bonds (Merrill Lynch 10yr US Treasury Futures Total Return Index) vs stocks (S&P Total Return Index), bonds have outperformed stocks since 1982. If you bought bonds and sold stocks in 1982 and held the position until now bonds would have outperfomed stocks by close to 600%. This does not take into account re-invested dividends for the S&P index stocks. If you include those, then the outcome is very different! Suffice it to say that the S&P total return index with reinvested dividends is at an all time high now. The (probably) counterintuitive conclusion, however, is that unless you rotated out of stocks into bonds before Lehman’s bankruptcy, not after, you will be under water on a relative basis (assuming you hold the position until now). In fact, at no point in time after Lehman’s it would have made any sense to buy bonds and sell stocks. Given that most of people rotated out of stocks into bonds after Lehman’s bankruptcy, they are right now all underperforming. How long before they realize it? How much underperformance pain a real money manager can take?

  6. When most individual investors hold bonds, the bond is held to maturity, often on Treasury Direct. It is not traded like a stock. It is a savings vehicle like a certificate of deposit, that is held solely for the purpose of collecting interest. In fact, muni bonds are more popular than Treasuries because their interest is free of federal tax. With munis, the biggest risk in the past has been that the bond will be called after its callable date (of course credit risk has to be considered today as well). Investing in “bonds” the way institutions do has been limited to choices on 401k and TSP funds.

  7. Look at a long term graph of Treasury interest rates vs year.

    The graph is stunning. The period from 1945-1981 was nearly 40 years of rising interest rates. That was one big long slow “drawdown” (or bear market) in bond value. The period from 1981 to present almost exactly mirrors the up-curve in one big bond bull. If it does continue to mirror, the turn should take place within a decade.