Ancient conventional wisdom says investors with a high tolerance for risk should skew their portfolios into stocks, while more conservative, longer term savers should lean towards bonds for more safety. As shown in the most recent data from Morningstar, the masses continue to run from stocks into the relative safety of bonds. In June alone $8.5 billion was yanked from equities, while more than $10b was invested in taxable bonds, and another $3.8b into munis.
According to Lincoln Ellis, chief investment officer at Strategic Financial Group, there's one big problem with the binary choice between stocks and bonds: it doesn't consider the possibility that both could collapse in tandem. Stocks, corporate bonds, Treasuries and munis are all being driven by the same forces. The upshot is that traditional notion of bonds -corporate or government- having more safety than equities is wrong.
"When the music stops the pain will not simply be in the equity space but in the fixed income space as well," says Ellis.
The singular force controlling seemingly all asset classes is, of course, the Federal Reserve. Unprecedented stimulus efforts have created a world of sub 1.5% yields on the 10-year, a rate lower than the subdued rate of inflation. Once forced out of Treasuries, investors have entered a high-risk world offering relatively low pay-offs. SPDR Barclay's Capital High Yield ETF (JNK) has a yield of about 7%. As the label "junk bonds" suggests, the debt owned in these funds has more or less the same risk profile as a basket of growth stocks meaning yield "should" be higher.
The glue holding this relative value jalopy together is confidence, according to Ellis. If markets lose faith in the Fed's ability to control the price of treasuries it all falls apart at once, setting fire to all the conventional wisdom investors have come to believe over decades. With that in mind Ellis is moving into non-financial equities with decent yields like the WisdomTree Dividend ex. Financials etf (DTN) and, more importantly, raising cash.
"We believe there will be an opportunity to find better relative value," he says. If there is it'll likely be at the expense a body of investors unaware they're exposed to any real risk at all.
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