Everyone knows the truism that retail investors are the “dumb money”, always last to the party, doomed to buy at market peaks and sell at troughs.
Indeed, it is daunting to invest one’s own hard-earned savings in treacherous markets, while professionals can at least parlay other people’s money with more poise. (A few may actually be more adept at it!)
I’d rather root for the underdog, but I fear the pros will trump the little guys once again. American individual investors are in droves and pouring into bonds, kindling more talk of a bond bubble. Statistics from the Investment Company Institute (ICI) show a continuing trend since the crisis in 2008, with bond flows positive and equities negative since April. Baby boomers, approaching retirement, have limited horizons, to wait for another secular equity boom.
Bond lovers represent an outlook for low growth, a possible double dip, deflation. Equities would favour recovery, probably with some degree of inflation down the road. Inflationists and deflationists are locked in a tug-of-war meanwhile, and no one has a credible clue on the timing. (article continues below)
Rather than constructing unreliable scenarios, why not base portfolio decisions on probabilities? The downside is that the Federal Reserve (and other central banking brethren) begin to raise rates in the next, say, year or two. Thomas Hoenig, a hawkish Fed governor, has consistently dissented at meetings, pleading for an initial rise to 1%, then to 3%, and a whiff of inflation could bring his fellow governors around. Investors may have to scramble to shorten durations: a bond portfolio with an average 10-year maturity would fall by 8% with a one percent rate rise; a five-year average maturity would sink 5%. The key is that it would take many seasons of coupon payments to compensate for the principal that even a modest rise in rates would obliterate.
With global rates so low, is it worth that risk to earn about 2.5% on 10-year Treasuries, or 2.25% on 10-year Bunds? Supposing stockmarkets tread water for many years, solid companies are paying dividends that easily rival bond yields, and offer prospects for an eventual upside.
Vanessa Drucker is the American Editor of Fund Strategy, based in New York City. She has worked as a financial journalist for 20 years. In the 1980s, she practiced banking and securities law on Wall Street, and is the author of two business novels. Vanessa can be contacted at email@example.com.