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Bonds lose luster as stocks see double-digit returns for '09, '10

Millions of Americans have turned their backs on the stock market since the 2008 crash.

But lately, some of them must be wistfully looking over their shoulders.

The Vanguard 500 Index fund, which tracks the blue-chip Standard & Poor's 500 index and is a staple mutual fund of 401(k) retirement plans, now is up about 15 percent year to date, counting price appreciation and dividend income.

Buy-and-hold bombed as a stock investment strategy from 2000 through 2008, but if this year's gains stick, the market will have generated back-to-back double-digit returns in 2009 and 2010.

Who knew?

For the past three months, stocks have been getting the benefit of the doubt from investors who are taking a much more upbeat view of the economy's prospects in 2011.

And that same mood shift is ruining the party in what had been many investors' favorite hideout since 2008: the bond market. Longer-term interest rates have jumped over the last two months, devaluing bond portfolios and leaving a trail of red ink in most fixed-income sectors.

That reversal of fortune may be particularly jarring because it was so easy for bond investors to be lulled into complacency over the past two years.

In the aftermath of the crash, Treasury, corporate and municipal bonds promised regular interest earnings and far less price volatility than stocks. What's more, as interest rates in many sectors of the bond market fell for much of 2009 and 2010, that decline boosted the value of older bonds.

The Pimco Total Return bond fund, the world's largest, gained 13.4 percent in 2009 and was up 11 percent in the first 10 months of this year, including price appreciation and interest earnings.

But since late October, the bond market's reputation as a refuge has been battered. As longer-term interest rates have risen, investors in most types of bonds lost money last month, at least on paper, and are in the red this month as well.

The losses generally aren't heart-stopping. The Vanguard Total Bond Market index exchange-traded fund, which owns a broad mix of government, corporate and mortgage bonds, is down about 3 percent from its record share price reached Nov. 4. The Pimco fund is off more than 3 percent.

Funds that own longer-term bonds, particularly tax-free municipal issues, have lost more. The average muni bond fund is down 4 percent since Sept. 30 but up 2.2 percent for the year, according to Reuters/Lipper.

Still, the mood change in the bond market has been palpable. Many investors are rethinking that most basic asset-allocation decision: how to split money between stocks and bonds.

Investors are demanding higher rates on bonds -- and are willing to pay higher prices for stocks -- for the same reason: They're betting that the economy will accelerate next year.

The Federal Reserve is trying to spur growth with its massive new program to buy Treasury bonds, launched Nov. 4. The Fed's goals are to try to keep longer-term interest rates suppressed and to funnel more cash into the real economy.

But the Fed had to know that if investors began to believe that it would succeed in boosting the growth outlook, interest rates might rise despite its bond purchases. Plus, bond yields had tumbled in September and October in anticipation of the Fed's move, so some snap-back shouldn't have come as a surprise.

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