Over the last 15 years, a troubling trend has emerged in the financial markets.
Bucking their financial advisors' guidance to use time-tested "buy and hold" approaches as well as proven balance and diversification strategies, some impetuous investors have been increasing their risk exposure simply by pivoting from one asset class to another. At the same time, they are going "all in" every time they pivot to a new asset class. Why all this changing? The search for higher returns, of course.
We believe this collective behavior has, among other things, artificially inflated prices across one asset class after another. This, in turn, has created a series of unsustainable bubbles in one market cycle after the next.
To be sure, there are long-term lessons for advisors and investors regarding herd mentality and groupthink. In the shorter-term, there are new buying opportunities. It's time for financial advisors to have a serious conversation with their clients about how the latest asset class pivots may have left bonds extremely undervalued, with significant upside potential for those investing long-term or trading over the short-term in individual bonds.
A brief summary of how this asset class-jumping behavior began is needed: It all started during the late 1990s, when investors rushed headlong into largely unproven dot-com equities before ultimately retreating into real estate, which at the time was considered a safe haven.
Then, of course, real estate collapsed along with a near-total collapse of the entire financial system. From there, terrified investors scurried in a mass wave toward precious metals and bonds.
The latest investor "all in" pivot has been away from the bond markets, where a reaction to recent comments by Ben Bernanke has provoked the largest sell-off in years, and a continued investor aversion to the entire asset class.
In signaling that the easy money policies of the past few years could soon be coming to an end, Bernanke said what few wanted to hear the economy is coming off life support. Largely ignored, however, was the fact that the Fed felt the economy is becoming healthy enough to come off life support in the first place
And there, perhaps, is the most important lesson of all: Often, investors only hear what they want to hear and more often than not have a very difficult time contextualizing broader economic trends especially when it comes to their own investments.
Viewed this way, it is very clear to us that current bond prices have become vastly undervalued. And while it may seem counter intuitive to say that both bond investors and traders have an opportunity while the market is in a tailspin, a closer examination reveals that there is indeed significant opportunity in today's environment.
Investors who have purchased individual bonds should consider the following before joining in the big bond sell-off:
First and foremost, remember the reason you purchased individual bonds in the first place. Very few investment vehicles offer the same risk profile and steady flow of potential income presented by bonds.
Also, remember that the price of the bond is only one of many factors to consider. If a bond has matured and the underlying fundamentals of the bond issuer remain sound, there is very little reason to worry about its value on the open market. Unless you have a need for additional liquidity, it may be best to enjoy the income while ignoring the day-to-day white noise of the financial media, which peddles in fear to drive ratings.
At the same time, traders of individual bonds should consider the following:
First of all, traders with even a rudimentary knowledge of how the markets have evolved over the past 15 years had to know that the fat times would come to an end at some point. With that in mind, the current landscape for the bond market is likely simply part of a broader pattern of shifts.
We believe the only difference this time around is that the asset class shifts seem to be happening more frequently. But that still doesn't change the fact that the underlying fundamentals of the bond market appear to remain quite strong. As previously mentioned, the Fed clearly believes that the US economy is strengthening. It has also stated that it intends to keep long-term interest rates low until the stubbornly high employment rate ticks lower. Taken together, that not only means potentially fewer defaults by borrowers across the board but that bond prices are likely to rise again. Less risk and a likely price resurgence may potentially provide superior return opportunities for traders who remain in the bond market.
Ultimately, for both the trader and the investor, therefore, the upshot is the same: Due largely to an emotional reaction to comments made by Ben Bernanke, much of the bond market may have been oversold. But when the dust settles, the decline in prices may create an opportunity to capture additional value. Interestingly, this stands in contrast to the stock market, which now appears overheated, as yield-hungry investors who missed the latest rally have jumped back into equities en masse.
Regardless of asset class used, when it comes to investing, slow and steady often wins the race. What we have witnessed since the tech boom of the late 1990s has been a series of false starts. Media pundits and talking heads, knowing that fear fuels ratings and leads to more clicks, have helped to feed this hysteria.
It's time for a little more investor moderation and for advisors to push their clients more vigorously towards this end. If nothing else, the past decade and a half has proven that.
Time and again, we have seen investors get burned after piling into asset classes on the ascent, only to rush out in a panic as they begin to free fall, turning the 'buy low, sell high' axiom on its head.
Those who treat the bond market the same way are likely to earn the same fate.
Andrew Ahrens is CEO of Ahrens Investment Partners, a wealth management firm. Its website is www.ahrensinvptr.com.