Friday, April 13, 2012

Main Street to Wall Street: Drop Dead

Random Glenings will take a brief holiday rest next week.  My next post will be Monday, April 23.

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Although the markets have lost a little ground so far in the month of April, the S&P 500 is still up almost +9% year-to-date, and nearly +25% for the last 6 months.

And while we are still early in earnings season, we have already seen some "upside earnings surprises" from such bellwether companies as JP Morgan; Alcoa; and Google.

Yet the general public is accelerating their departure from the stock market.

According to Michael Hartnett at Merrill Lynch, last week saw:

A week of risk capitulation.

Biggest outflows of 2012 for equities and commodities; first outflows of 2012 for High Yield and {Emerging Market} debt funds.

In contrast, inflows to Treasurys (largest since August 2011) and investment grade bonds.

In short, Main Street is giving a collective Bronx cheer to the investment community, which continues to sing the praises of stocks relative to bonds.

One of my colleagues told me that he has seen some data that indicated that nearly 80% of institutional investors had a positive view on the outlook for the stock market - but nearly the same percentage (80%) of individual investors had a negative view of the stock market.

In one way, this is not surprising:  the recent signs of economic strength have not translated in any meaningful way into either wage or job growth.

It's hard to get excited about stocks when you're worried about making ends meet.

Yet for retirement assets - which for most workers should have a long term time horizon - it seems that a majority of workers would rather earn less than 1% in a US Treasury or high grade corporate bond fund rather than stocks.

It will be interesting to see what happens when interest rates begin to rise.

I don't know when rates will rise meaningfully, but it only will take a small move higher to wipe out the coupon income for a year.

For example, the 10-year Treasury note yields around 2%. If the same note a year from now is yielding 2.25% - a tiny 25 basis point rise in interest rates - the capital loss of -2% will negate the coupon income for the entire year.

Now, if you buy a bond directly, as we do here at my bank, you will at least be assured that you will get your money back at maturity.

But there is no such comfort in buying a bond mutual fund, meaning that investors in bond funds could face significant losses in the years ahead.