Sunday, March 31, 2013

The LONG TERM Tide for Individual Investors Has Shifted ... Even Active Bond Managers Are Now Moving To Stocks From Bonds

We've been recommending for some time now that long term focused individual investors should not buy bonds, and if that they already own them, they should sell them and switch that portion of their investment portfolio to blue chip dividend paying stocks instead.

And it's an approach that we would suggest be followed for at least the next decade and perhaps longer, depending upon when inflation next peaks or reaches 5% or more, which isn't likely to occur for a long time.

Stated simply, solid dividend paying stocks are and will be a better and safer investment vehicle than bonds for many years to come. And bond funds do lose value as interest rates increase, contrary to popular belief.

Thus, unless we intend to keep the bond until its maturity date, we're always subject to the very real risk that interest rates will rise and the value of our bond fund investment will be less that what we paid initially. In an environment of rising interest rates, that puts the bond investor in the ongoing predicament of continuing to own a low interest rate bond or taking a loss on the principal value of that bond when selling it.

Then as interest rates keep rising over time, the situation repeats itself until interest rates peak. And that process is likely to take years this time since interest rates are at historic lows today and higher inflationary conditions are definitely in the risk picture for the foreseeable future.

Increasing inflation, rising interest rates and lower bond values go together. Thus, bond buyers beware.

Simply put, there's nothing safe about investing in bond funds these days, and the market risk of loss is real while the potential for reward is zilch.

In fact, now even bond managers are beginning to purchase stocks as well. That sounds like the the beginning of the end of long term bonds as an appropriate individual investment vehicle for the foreseeable future.

Funds Reshape Investment Mold says this:

"Hedge funds that specialize in bonds are bulking up on stocks, in the latest sign of investor concern over the health of the long bull market in debt prices.

Fund managers that have made winning bets in corporate loans, mortgage bonds and distressed debt are altering course after a flood of cash has pushed up the prices of all sorts of debt investments, raising risks and depressing expected returns.

The shift, which comes as a widely followed measure of bond performance is on pace for its first negative first quarter in seven years, represents a new source of fuel for potential stock gains. . . .

Crescent Capital Group, a $12 billion fund manager that primarily buys below-investment-grade loans and bonds, has boosted its investments in stocks to 10% of assets from virtually nothing last fall, said co-founder Mark Attanasio.

"We have looked for stock investments where we can get more yield" than from bonds Mr. Attanasio said. "Our clients want to see it as a sweetener.". . .

"Credit fund managers see an opportunity in the equity space, and they are going there," said Hiroshi Harada, head of research at HedgeMark Advisors LLC, a hedge-fund monitoring firm.

The Barclays U.S. Aggregate Bond Index is down 0.24% through March 26, on pace to produce a negative first-quarter return for the first time since 2006. The index is 36% invested in Treasury securities, whose yields have climbed this quarter, reflecting improving economic conditions and a more certain outlook after the fiscal-cliff resolution.

Hedge funds aren't the only investors shifting course. According to investment-research firm Morningstar Inc., 309 bond mutual funds owned stocks at the end of December, the highest number in at least a decade. . . .

After 2009, investors became cautious about the U.S. economy and faltering corporate health, and many pared stock investments and jumped into credit markets instead. Bonds are generally considered safer investments than stocks because if a company files for bankruptcy protection, bondholders stand ahead of shareholders in line to be repaid. . . .

The higher bond prices rise, the less they yield and the greater the risk of losses should markets turn. While investor demand and other factors can temporarily push bond prices above 100 cents on the dollar, those who hold the securities to maturity can expect to receive no more than their full investment back, a fact that limits the rise of bond prices. Stock prices, on the other hand, can theoretically rise without limit.

One possible trigger for a bond selloff is that with the U.S. in an economic recovery, the Federal Reserve may be preparing to raise interest rates. Rising rates hurt bonds because they damage the value of old bonds issued at lower rates."

Summing Up

For the past three decades, interest rates have fallen from initial double digit levels. And bond investors were rewarded as bonds performed well because of a long period of declining interest rates.

Now the tables have turned and interest rates are at historic lows. They have nowhere to go but up, so bonds wil perform poorly for at least the next decade or so.

Bond money is beginning to move to stocks, and the law of supply and demand dictates that this will be good for stock prices and bad for bonds.

There's nothing new here except the fact that interest rates won't be going down the next several years. Instead they'll be going up.

Let's all remember Wayne Gretzky's advice about the importance of skating to where the puck will be as it applies to interest rate movements and individual investing.

Because Gretzky's tip applies not only to playing hockey but will work as well for individual investors when deciding whether to invest in stocks or bonds for the long run.

That's my take.

Thanks. Bob.

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