I’ve been noticing commercials on financial TV and radio–why I turn on the functional equivalent of the WWE, I don’t completely understand–for gold. They tend to go like this: NOW is the time to buy gold!!! Why? …because it’s 4x the price it was ten years ago.
In other words, buy because prices are very high. That’s crazy.
Bond funds have had a similar pitch over the past few years. Faced with near-zero, emergency low, interest rates, which imply sky-high bond prices, bond fund managers invented a marketing pitch that became known as the “new normal.” The thrust is that we are in a post-apocalyptic world, where the earth’s economy has been scorched and will be incapable of growth anywhere on its surface for, say, a decade. Therefore, buy bonds, avoid stocks.
Interestingly, bond funds haven’t had much trouble popularizing this view. Bonds, like gold, have performed much better than stocks for a long time. So bond funds have collected lots of assets and are big advertisers in the media. And, of itself, the fact that rich and successful people would be predicting a global “lost decade” is a newsworthy story.
As I’ve noted a number of times, one characteristic of this point of view is that it’s very self-serving for bond people. It’s the only scenario I can think o of where it doesn’t make sense to rebalance your portfolio–to take money out of the strong-performing, high-priced asset, bonds, and put it into the weaker-performing, lower-priced asset, stocks.
Cynics would say that bond managers just told investors a story that would keep them from taking money out of bonds, thus reducing the managers’ income. They’d probably also point out the quiet diversification of Pimco, the largest bond manager, into stock funds about a year ago. But, however implausible the idea might have been, it’s possible that bond managers actually believed it. After all, there’s a powerful psychological tendency, that professional investors have to constantly fight, to screen out facts that call into question the way your portfolio is set up. And after twenty-five years of almost non-stop success, it must be very hard even to conceive that things might not go your way.
Four factors are beginning to call into question the new normal/by bonds thesis:
1. Economic growth, which has been very strong in the emerging markets (40%+ of the world), is beginning to pick up in a meaningful way in the US as well.
2. Stocks are starting to outperfrom bonds in a meaningful way. According to Barrons, over the past year, actively managed bond funds are up 6%+and their US stock counterparts are up 18%+ (compared with the S&P 500 being up 12%+).
3. Individual investors have stopped putting new money into bond funds. For some time, they have been selling municipal bond funds on concerns about credit risk. But the most recent data suggest withdrawals are spreading to taxable bond funds as well.
It’s not clear what people are doing. Some data sources show funds beginning to flow into equities. Others indicate most is being parked in money market funds.
4. Last week, the Pimco Total Return Fund, perhaps the most famous bond fund in the world (as well as the home of the “new normal”), has announced it will change its investment guidelines so it can put 10% of its money into equity-linked securities, like convertibles. According to Bloomberg, many other bond funds have been investing in equities for a while and ar leaving Pimco behind in the dust.
I think these developments are bullish for stocks.
In the counterintuitive way that Wall Street thinks, it’s a little worrisome to have the last great equity bear, Pimco, capitulate. Still, stocks appear cheap, the US is growing again, and the flow of funds data don’t yet show a great deal of investor enthusiasm for equities. It’s not to soon to start to worry that the best may be behind us for this equity cycle (after all, we are about to enter year three of bull market), but it’s way too soon to act.
On a technical note:
If history is any guide, the current active manager outperformance of the S&P 500 can’t continue. It would explain, however, why professional equity investors appear to have closed up shop for the year a couple of weeks earlier than usual.
I haven’t looked to see what kinds of equity-linked securities bond funds are buying. But S&P companies typically don’t issue convertibles. So the risk exposure the funds are taking on may be somewhat different (probably higher) than what one might expect.