One of the top discussions among market mavens is whether we have begun a shift away from bonds into stocks by institutional and individual investors alike.
US equity mutual funds shed assets again last year, in spite of a double digit market rise. Yet for the first month of 2013, equity fund flows have turned positive. After a 125 % gain off the panic lows of March 2009, the S&P 500 now sits at 1500. Bullish sentiment of 54.7 % has risen near its 5 year high of 58.8 % according to Investors Intelligence. Bears are currently at 21.1 %, signaling investors are feeling confident after this 4 year BULL run.
Our job is to allocate your assets according to your individual risk tolerance, goals, and investment objectives. It is most important to have a frame of reference as to where markets now are in terms of economic and valuation cycles. Additionally, we need to diversify among various asset classes as well as weigh the risks against the potential rewards of a given asset. Typically we look to history as a guide. We have witnessed significant changes over the past 30 years. Most notably, US Treasury bonds have gone from having 14.0 % yields in 1981 to 1.40% in mid-2012. We have beaten back the 1970’s era of inflation. US stocks have rallied from about 1000 in August 1982 to 14,000 on the DJIA currently. There are few straight lines in investing. Treasury bond yields have declined steadily over 3 decades and the US has gone from a large creditor nation to the biggest world debtor of all time. Yet yields have declined as 1970s peak inflation turned into 2008 deflation. A generation of Investors has only experienced declining yields and politcians have yet to feel the public’s wrath for too much spending. We believe however that the rising tide of bond prices has crested.
We no longer expect positive returns in long dated US Government Bonds.
Since the bailouts of European banks last summer, both the ECB and the Ministry of Finance in Japan have followed in the Fed’s footsteps. All three major currency blocks are printing money via asset purchases. These actions have propelled global stock markets higher and have helped stocks outperform bonds since mid 2012. Pension fund investors with bogeys of 7-8 % for expected returns can no longer rely on bonds to reach their goals and meet promised payment levels. Even high yield low quality corporate bonds yield below 6 %.
Many individual investors are understandably spooked by the enhanced volatility of stocks since 2008.
Stocks are still cheap relative to bonds and have favorable tail winds from rising dividend yields and increasing percentage payouts of their earnings steams. Corporations sit with trillions in cash on their balance sheets and record profit margins. Global GDP growth is anticipated to be 3.2 % this year. U.S. GDP growth is anticipated at 2% and the consensus earnings estimate for the S& P 500 is $110/share putting the PE ratio at a level of 13.6 times forward earnings which still reasonable and below the historic norm.
It is not a 1980s or 1990s bull market, but we are clearly experiencing a rising trend, so we’ll work with it. This January’s rally in stocks typically presages a profitable year ahead. Despite the increased volatility during 2008-2012 where the median loss in the S&P 500 was 19 % versus an average of 11% in the 1970-2012 periods, investors who can handle the volatility will likely reap rewards.
Douglas Coppola
Feb 7 2013
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