Monday, January 14, 2013

Investors Load Up on Stocks, and Worry about Bond Funds

The headline on the front page of Saturday's Financial Times said it all:

Billions pumped into global equities
  • Inflows highest in five years
  • Fiscal cliff deal boosts confidence
  • Move out of safer assets
Following by an article which noted, among other things:

Net inflows into equity funds monitored by EFPR, the funds research company, hit $22.1 bn in the week to January 9 - the highest since September 2007 and the second highest since comparable data began in 1996. Record inflows into emerging market and world funds drove much of the expansion.

Meanwhile, Fortune magazine came out with a piece today titled "The ticking time bomb in bond funds".  The article highlighted the fact that many bond funds have stretched maturities to unusually lengthy levels in an effort to maintain yield:

The latest victim of Wall Street's reverse alchemy: Bond funds. In the past year or so, managers of these funds have been loading up on debt that on average won't be paid back until at least 2018, and in some cases much, much later....

This seems to be a particularly perilous time to be buying debt tied to the second half of this century. The yield on the 10-year Treasury bond has risen to a recent 1.9%, from 1.6% a month ago. Many market gurus say that this may finally be the year that interest rates, which have been at historic lows, march up.

That's bad news for all bond investors. But it could be a potential disaster for anyone invested in a fund that's betting on longer-term debt. Bond prices move in the opposite direction of rates. And the further a bond is from when it's due to be paid back, the more it'll lose when interest rates rise.

I still worry that we are due for a correction of -5% to -10% at some point - there just seems too much bullish sentiment at this point - but if money starts moving out of bond funds into equities this might be a nice catalyst for gains later this year.