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July 9, 2015

Bond and Stock, Who's the Scariest of All?

Worried about your bonds? You’re not alone.
In speaking with our investors in recent weeks, the most universal theme by far was concern over their bond holdings. Historically low interest rates coupled with the prospect of the first Fed rate hike since 2006 (“rising rates”) were causing anxiety. And most importantly, the average bond fund was down in the first half of the year. There’s nothing more fear-inducing to investors than short-term losses.
To be fair, some of these concerns are warranted. The elephant in the room is that lower bond yields are likely to lead to higher volatility and lower returns going forward. Investors who aren’t preparing for this are surely to be disappointed.

But what about stocks? Given negative earnings growth in the past two quarters and extreme valuations, you would think there would be some level of concern there as well.

But surprisingly, these same investors who were fretting about their bonds seemed extraordinarily complacent when it came to their stock holdings.
Why? Well, it’s been a long time since stocks have done anything but go up. The Russell 3000 has advanced 12 consecutive quarters, the second longest streak in history. As I wrote last week, U.S. stocks have been behaving like a 6-month CD.
Does that mean investors are right to be more worried about their bonds? No. This is recency bias in its worst form. Even a cursory examination of the history reveals higher risk in equities…
Looking at the rolling 12-month volatility of stocks and bonds, we see that 99% of the time stocks have exhibited higher volatility than bonds. Only in the early 1980’s when interest rates on U.S. 10-year debt approached 16% did bonds briefly experience higher volatility than stocks.
In looking at historical drawdowns, there’s no comparison. The S&P 500 has fallen in excess of 50% while the worst decline for the Barclays Aggregate was 12% (using monthly data). Bonds have also held up very well during periods of higher volatility in equities, traditionally acting as a defensive position.
Now, I’m not suggesting that fear has any place in managing a portfolio. When it comes to investing, it is best to leave emotions out of it and stick to a systematic process whenever possible.
But if you’re going to worry about anything, given the historical record stocks would be a much more rationale choice. Equities are not the new “safe haven” despite their behavior in recent years. And from a contrarian standpoint, the fact that no one is worried about stocks today is probably telling us something. Invariably, just when the masses think nothing can go wrong in the investment world, a surprise is coming.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

About the Author:  Charlie Bilello, Director of Research at Pension Partners, LLC with a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. He also holds the Certified Public Accountant (CPA) certificate.  (Article Archive Here)
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters. © EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle

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Item Reviewed: Bond and Stock, Who's the Scariest of All? Rating: 5 Reviewed By: EconMatters