It feels like years that we have been writing about the forthcoming “great rotation” in markets, or the big move out of fixed income and into equities. It has many times been predicted, and generally fallen far short of expectations. However, it may be about to occur, says Bloomberg. For the first time in a long while the risk-adjusted return on stocks has been outperforming bonds, a key factor in how the market might turn. “Flows do follow performance, and we know U.S. retail investors are less valuation-sensitive than smart-money investors … The increase in total returns from stocks, if it continues over the next couple of quarters, raises the prospect of a tipping point in asset allocation in favor of equities”, summarizes an equities analyst at Credit Suisse.
FINSUM: Perhaps a great rotation has not fully happened, but US average allocation to equities is near a long-term high, so it is not as if people have been holding back. We are still skeptical allocations are going to change much from here unless the Fed gets really active with hikes.
The Wall Street Journal has published an article arguing that many investors are wary of the bond market purely because of misunderstandings. This may also be the reason that many lose money in the market. One of the key elements that seem to be poorly understood is that fact that the bond market is not unified in the way stocks are. It is composed of hugely variant types of bonds, all with their own pricing, so views such as “the bond market is overpriced” are too generalized to be relevant. Additionally, many seem to forget that one of the primary purposes of bonds in a portfolio is to hedge against stock losses.
FINSUM: It seems there is still a lot of room for human advisors to educate clients about the opportunities and risks in the bond market. This seems especially true at a time when stocks are doing so well.
The yield environment, despite many hopes, has stayed weak, with investors hungry to grab anything above the paltry average yield. This has led to a flood into municipal bonds, which have tax-free advantages and are considered safe. However, the reality is that many area’s creaking public budgets mean munis seem to be not nearly as safe as many presume. Hartford, CT, Illinois, and Puerto Rico, for instance, are having very significant budget problems. Yet, municipalities continue to increase borrowing, and investors are snapping up the debt at an increasing pace, with sales this year up 8% over the same period in 2016.
FINSUM: The system appears to be fraying at the edges, and it seems like over the next few years many investors are going to be burned badly.