Will The Bond Mania End Ugly?
Halbert Wealth Management
By Gary D. Halbert
March 7, 2012
1. Investors Shun Stocks Like the Plague
2. Bond Funds are the “Darlings” of Today
3. Treasury Bonds are Safe, Right?
4. Is Your Bond Fund Really in Treasuries?
5. How Much Lower Can Interest Rates Go?
6. Let’s Not Forget the European Debt Crisis
7. The Love Affair With Bonds May End Ugly
Investors Shun Stocks Like the Plague
Since the stock market bottom in March 2009, the S&P 500 Index has almost doubled. That’s a gain of apprx. 100% in three years, one of the strongest moves ever. Yet investors have been dumping stocks like they’re the plague over this same period. Actually, this migration away from stocks began even before the Great Recession and the financial crisis of 2008.
One of the best ways to gauge investor behavior is by looking at mutual fund inflows and outflows by category. The Investment Company Institute provides such data on a weekly basis for various types of mutual funds. The chart below illustrates how investors have shunned equity funds in droves since 2007.
I don’t have to remind readers that the S&P 500 Index plunged just over 50% in one year’s time in 2008 and early 2009. This was the worst loss that many investors had ever experienced. Many panicked and bailed out of the market at this time as you can see in the blue bars in the chart above. As you can also see, there have been only a handful of positive months where there were net equity fund inflows since then.
I remember friends telling me back then that if the stock market ever got back to anywhere near the peak, they were going to sell everything and get out to the market for good. But in looking at the chart above, we see that millions of investors bailed out before and after the S&P 500 Index topped 1300 last year. Equity fund outflows were huge in late 2010 and again last year.
Bond Funds are the “Darlings” of Today
It is impossible to know where the millions of investors that have redeemed from stock funds over the last five years put all of their money, but it is very clear that a lot of it went into bond mutual funds. Take a look at the table below.
Bond Mutual Funds
|2007||-$65.3 bil.||+$97.4 bil.|
|2008||-$148.2 bil.||+$21.8 bil.|
|2009||-$28.1 bil.||+$311.3 bil.|
|2010||-$94.9 bil.||+$229.9 bil.|
|2011||-$134.7 bil.||+$136.0 bil.|
|TOTAL||-$471.2 bil.||+$796.4 bil.|
Source: Investment Company Institute
Folks, that is one monster shift in asset classes! Investors have moved en masse out of stock funds, and many have moved to bond funds. And the trend continues this year.
ICI data shows that through the third week of April, investors pulled another $31.7 billion out of stock funds this year, whereas bond funds saw additional inflows of a whopping $100.4 billion in less than four months.
Obviously, the inflows to bond funds represent a LOT MORE investors than just those redeeming from equity funds. Investors have moved into bond funds in droves since the stock market bottom in March 2009.
To be clear, there is no way to know how much of the $471 billion that left stock funds in the last five years went into bond funds. Certainly not all of it went into bond funds. But it’s pretty clear that a lot of it went into bond funds. This has been one of the largest shifts I’ve ever seen.
Take note that of the $796.4 billion in bond fund inflows, $677.2 billion – or 85% – came in only in the last three years after interest rates had fallen to near historical lows. It won’t take much of a rise in interest rates for many of these folks to be underwater.
Treasury Bonds are Safe, Right?
Most people believe that bonds are less volatile than stocks overall. That is not always true. Ask people who owned bonds back in the late 1970s and early ‘80s. As you can see in the chart below, Treasury bonds can be quite volatile.
Most people also believe that Treasury bonds are safe, if held to maturity, because they are backed by the “full faith and credit” of the US government. Yet when you buy a bond mutual fund, you are buying shares in the fund; you do not own the underlying bonds individually. It is the fund manager that decides which bonds to own and when to sell them. In most cases, the investors don’t know when the bonds mature.
The only way to own Treasury notes and bonds with the full faith and credit of the government is to buy them directly from the Treasury or in the secondary market through a broker and hold them in your account until maturity. Bond funds are not as safe as the current public perception, in my opinion.
Is Your Bond Fund Really in Treasuries?
A lot of investors pay little attention to the underlying holdings of the mutual funds they own. Some mutual funds that claim to be bond funds may have little to no exposure to Treasury bonds. Take the PIMCO Total Return Fund, the world’s largest bond fund ($252 billion at last count). This fund is run by Bill Gross (the “Bond King”).
In early 2011, Gross announced that he was selling ALL of the fund’s Treasury bonds. The only Treasuries that remained in the fund were those with maturities of one year or less. This came as quite a surprise to many, including I’m sure, some of his shareholders.
As it turns out, Gross was early. As you can see in the chart above, T-bond yields fell further in the second half of 2011 to below 3% at one point, and the Total Return Fund missed out on some additional profits.
Of course, Gross had no way to know in early 2011 that we would have one of the nastiest debt ceiling debacles ever last summer, or that Standard & Poor’s would downgrade America’s debt rating from AAA, not to mention the worsening debt crisis in Europe. All of these things increased investor demand for Treasuries for safety reasons. This helped to push yields even lower.
I should also note that the PIMCO Total Return Fund is not a Treasury bond fund per se. Gross invests in a variety of bonds and other securities. In an interview in March, Gross said he had resumed buying Treasuries for the fund, but noted that he was still avoiding the longer maturity Treasury notes and bonds.
The point is, if you think you are in a Treasury bond fund, you probably should check the fund’s holdings to be sure.
How Much Lower Can Interest Rates Go?
Fed Chairman Ben Bernanke assures us that short-term interest rates will be maintained near zero until at least late 2014. Let me emphasize that this is the Fed’s intention, but that could change. While Bernanke still has a majority of FOMC members who agree with him, the number that do not is increasing.
Likewise, the Fed appears confident that inflation will remain low over that period as well. This, too, could change. While commodity prices have generally moved lower this spring, there’s no guarantee that they won’t surge again this summer. While the price of crude oil has dipped below $100 per barrel for the moment, it could well soar again this summer.
The Consumer Price Index rose 2.7% for the 12 months ended March, down from 2.9% in the 12 months ended February. That’s still well above the Fed’s supposed target of 2%. If inflation starts to move higher later this year, that could be bearish for bonds.
The question is, how much lower can US rates go? The benchmark 10-year Treasury Note yield is once again below 2%. One wonders how it can go much lower, unless we are headed back into recession.
In my view, the risks favor higher rates from here, not lower.
Let’s Not Forget the European Debt Crisis
Among the things that can rattle the bond market, keep in mind that the European debt crisis not been stabilized. The economies of the most troubled countries have dipped into recession. Unemployment is at record highs. I expect the situation to get worse before it gets better. More bailout loans from the European Central Bank almost certainly lie ahead.
Then there’s the latest presidential election in France in which socialist Francois Hollande defeated President Nicolas Sarkozy. Hollande has promised to roll back planned budget cuts and austerity measures and increase government spending.
To pay for his plans for increased government spending and the rollback of austerity programs and budget cuts, Hollande proposes to increase the income tax rate on those making one million euros or more a year to75%. Never mind that doing so won’t create enough additional revenue to pay for his spending plans. Wealthy Europeans will find ways to reduce or change the nature of their income or leave the country.
Mr. Hollande’s ability to govern France will be greatly impacted by the outcome of the legislative elections on June 10 and 17. All 577 members of France’s General Assembly will be up for re-election. Currently the UMP (Sarkozy’s party) has a majority in the Parliament and is allied with the Nouveau Centre Union (NC) in forming the government. This allows the governing coalition to appoint the Prime Minister and have strong influence on the president’s cabinet appointments and policies. Should the UMP/NC coalition hold (which is likely) Mr. Hollande will find it very difficult to get anything of substance done.
Nevertheless, Hollande’s election sent shock waves through the European and Asian markets on Monday. The ongoing European financial crisis can have serious implications for our markets, as we have seen in recent months, including the bond market.
The Love Affair With Bonds May End Ugly
Mass migrations of the investment public from one asset class to another have often ended very badly. We can all remember the late 2000-2002 bear market in stocks when the S&P 500 plunged almost 50% and the Nasdaq over 70%. Investors had been in a mania for stocks during the late 1990s.
I believe what we’re seeing today qualifies as a mania for Treasury bonds. After seeing the numbers I showed you above, I suspect you would agree. I’m not predicting that the current bond bubble will end the way the dot.com mania ended, but it won’t take a huge increase in interest rates to put a lot of bond fund investors who came late to the party underwater.
At Halbert Wealth Management, we have several professionally managed bond programs that have the potential to get out of the way should something unexpected occur. One of the bond managers we recommend can go long or short in Treasury bonds.
Feel free to call us at 800-348-3601 or visit our website www.halbertwealth.com.
Three-Way Race: Romney 44%, Obama 39%, Ron Paul 13%
Finally on a political note, many Republicans have expressed serious concerns that Rep. Ron Paul may run for president as a third party Independent. They fear that Paul would drain votes from Romney, thus ensuring President Obama’s re-election.
However, a new Rasmussen poll released this morning has raised some eyebrows! In a national survey of 1,000 likely voters on May 6-7, Rasmussen found that in a three-way race, the results would be Romney44%, Obama 39% and Paul 13%. The margin of error was +/- 3 with a confidence level of 95%.
This poll has to be a stunner for the Democrats, many of whom have been hoping that Ron Paul would run as an Independent, even though Paul has said he has no plans to do so. You can bet that the Dems are thinking just the opposite after today’s surprising Rasmussen poll!
Rasmussen’s Daily Presidential Tracking Poll taken yesterday has Romney at 49% versus Obama at 44%. This is Romney’s strongest showing this year. Romney has been trending higher against Obama since early March.
As we all know, anything can happen between now and the election in November. As always, it will come down to the Independents, many of whom are disillusioned with President Obama, but they’re not in love with Romney by any stretch. Time will tell.
(c) Halbert Wealth Management