For the last two months, I have been warning that long-term interest rates are going to surprise on the upside at some point, and when they do it will be bearish for bonds. Yet despite that risk, investors continue to flee stocks while at the same time pouring more and more money into bond funds.
Even though the S&P 500 is up more than 115% since it bottomed out in March 2009 – and its closing price of 1,461.40 yesterday is within striking distance of its all-time high of 1,565.15 — investors continue to bail on US stock mutual funds.
Altogether, investors yanked $311 billion more from actively-managed US equity funds than they put in over the three-year period through July 31, according to the Investment Company Institute (ICI) that tracks mutual fund money flows. If we look all the way back to 2007, investors have withdrawn over $500 billion from stock funds. Clearly, investors are looking for something safer than stocks in the wake of the financial crisis.
So where has a lot of that money gone? Three guesses (and the first two don’t count): bonds! Over the three-year period through July 31, investors plowed a whopping $673 billion into taxable bond funds (including Treasury bond funds). If we look all the way back to 2007, investors have added almost $1 trillion to taxable bond funds – again looking for something they perceive as safer. Boy could they be in for a surprise!
And these stock outflows and bond inflows have continued in recent weeks, despite The Fed’s recent announcement of the open-ended QE3. Even though the Fed’s announcement of QE3 was widely expected, and the unlimited size was more than expected, you would think investors would be pouring into stocks and stock funds. Not happening!
Let’s look at the weekly fund money flows just before and after the QE3 announcement on September 13. The chart below shows the outflows from domestic equity funds over the latest five weeks for which we have data, along with the inflows to bond funds.
What we see is that stock fund outflows actually increased before and just after the QE3 announcement on September 13. Remember just about everyone believed that QE3 would drive stocks significantly higher. At the same time, bond fund inflows increased significantly during the same period.
Obviously, investors perceive that bonds have lower risk than stocks. They could be very wrong! The yield on 10-year and 30-year Treasury bonds remain near their all-time lows (closing yesterday at 1.62% and 2.81%, respectively). I wonder how much lower those who bought bonds and bond funds recently think rates can go.
What they should be thinking about, in my opinion, is how much HIGHER rates could go from these historical lows! Remember that it is estimated that a mere 1% rise in long rates would lead to a loss of apprx. 9% in 10-year Treasuries and a whopping 20% in 30-year T-bonds.
The millions of investors in longer-term taxable bonds will incur losses when interest rates start to trend higher as they inevitably will at some point.
Earlier this year, we did a survey of our hundreds of clients all over the US and the hundreds of thousands of people who read my weekly E-Letter. To my surprise, over 50% of each group told us that they are invested in long-only bond funds. These are the very funds that will get hurt the most when interest rates trend higher.
It doesn’t have to be that way! Since I started this blog over a year ago, I have not included any promotion of the investment opportunities we offer at Halbert Wealth Management. However, with the train wreck I see coming in bonds at some point, I’m going to make a brief exception.
If you haven’t already, I highly recommend that you take a serious look at the Equity Alternative Program which invests both long AND short in Treasury bond mutual funds. This professional money manager has an excellent long-term performance record with very good risk controls. The minimum investment is only $25,000.
No one knows when interest rates will start to trend higher; we just know that they will at some point. If you are in long-only bonds or bond funds, you may want to consider a highly successful strategy that has the potential to make money for you no matter whether interest rates go up or down.
As always, past results are no guarantee of future performance.
Have a great weekend everyone!
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