Seems so long ago. Markets were tumbling. People who owned stocks were selling and running for bonds. People who owned actively managed mutual funds were moving everything they had left to the uncharted and unproven territories that are target date funds or balanced offerings. No one seemed to know what to do or worse, how to do it.
And now, fifteen months later, as we brace ourselves – somewhat optimistically – for 2010, some of us feel good while others still feel as though they missed something. A recovery can be a feeling of warm fuzzy consolation that that things are getting back to normal. Money is being made and all is well.
Belief that this will continue into the New Year is somewhat naive. When an investor panics, they sell. They believe that no price is too small to unwind a position. That “position” be it in a fund that was aggressive or simply one that was in equities was quickly kicked to the side for something, anything that would offer a safe haven. In 2010, this sort of thinking will bite you hard for entertaining these thoughts, even if it seems as though you may have gained some ground.
Once upon a time, investors panicked and bought bonds in funds, in target date funds and in balanced funds. This sort of massive inflow pushed the price of bonds up, even Treasuries because, as many of these new “conservative, I-want-to-protect-whats-left” investors failed to realize how bonds work. In short, when the price goes up, the yield goes down. And vice versa.
The reason for this is simple for long-term bondholders to grasp. But these newbies may have missed this nuance.
The price of a bond, even the ones tucked away inside your conservative fund react to investors in two ways. If investors do not want to buy bonds (essentially loans issued with a yield) the price falls below par and the yield goes up. To most who understand this relationship, when the yield goes up so does the risk that the bond issuer might not be able to pay for the “loan”.
When the price goes up, the opposite happens. When the price goes up because a huge amount of people suddenly think that conservative is how they should have always been investing, the price goes very high and the yield goes down – a lot.
US government issued bonds experience the same sort of turmoil even if investors believe that they can never lose money in these instruments. You can, if the maturity is long enough that investors, once they feel as though stodgy is no longer needed begin to sell. You are left with expensive positions as the price falls.
But you will find in the coming months that not just you have made this sort of mistake. Your fund managers of those target date funds, balanced funds or otherwise conservative bond funds will be faced with a changing interest rate landscape and a shift in investor sentiment.
The interest rates, which have been at historic lows for too long wil have to come up. While banks are building thier asset base on the backs of this cheap money, they have failed to stimulate the economy. The stock market, acting as a soloist in this economic symphony, has been play its heart out. Although everyone agrees an increase in rates signals the first acknowledgment that the economy is recovering, it will not so fully embraced by businesses.
You will panic, sell your conservative positions, forcing the fund managers to unwind some of their positions to pay you as you leave, and you will flock to equity funds – when they publish their 2009 year-end results.
This is the shift in investor sentiment that will find itself slightly behind the curve. The smuggest of investors will be the ones who didn’t panic. The folks who allowed their portfolios to recover and their fund managers to realign themselves with the original reason you invested in the first place will find their portfolios almost fully recovered.
Those that panicked again will trigger a taxable event that will drive these supposedly guaranteed returns down even further. The indexers will claim vindication and use the opportunity to boast about their investment style as the only way to go.
The real winners for 2010 will be in dividends and the funds that invest in them. Often referred to as equity income investments, these funds will begin to shine as businesses begin to increase their profit sharing (which is what dividends are) even if they have not begun hiring.
These businesses will be more likely to have a broader, beyond-the-US-consumer focus and the fund managers who focus on these opportunities will move to the top of the investment heap. If you were to to invest in these kinds of funds, next year will be too late to capitalize on the shift many investors will make as the calendar year changes.
Paul Petillo is the Managing Editor of Target2025.com