Have We Recovered Yet? 

 

For several months now the news has been that the S&P 500 index is reaching new all-time highs.  Nevertheless, I think many investors question whether we are out of the woods yet.  Experiencing the second and third worst markets in modern history has left investors cautious at best and, at worst, a bit scarred by the experience.

Investors as a whole own fewer stocks today than they did before the 2008 recession.  On average, today’s investor has roughly 40% of their portfolio in stocks compared to about 42% in late 2007 and an all-time high of 52% in early 2000. 

Meanwhile, bond ownership is hovering near an all-time high.  Whenever an asset class is at an all-time high as a percentage of investor accounts. It gives me pause.

I continue to think investors are underestimating the risks in the bond market.  There are two aspects of bond risk.  First, when interest rates rise, bond prices fall.  I do not foresee a sharp rise in interest rates, but I may be wrong.  Second, low quality bonds can move significantly if there is a credit scare.  In the last few years a lot of money has flowed into lower quality bonds in an attempt to get higher yields.  How quickly investors have forgotten that low quality bonds were hit as hard, if not harder, than stocks in the 2008 crisis.  Stretching for a little more yield can be a very dangerous habit in a low interest rate environment.

 

The markets are impossible to predict, partly because the behavior of people in aggregate, as well as individually, is impossible to predict.  One possible future scenario could have the investing public increase their stock exposure.  Since higher levels of demand are one engine that drives stock prices higher, we could experience more years of high returns.  This could, in turn, bring about one of those cycles that feeds on itself.  Until, of course, the next downturn – which, alas, is also unpredictable.

 

While long-term investors have enjoyed some of their best years, the tragedy is those who have largely missed out on the recovery returns since 2008.  It is the nature of markets to frighten people off and lure them back in as stock prices are just about to go over a cliff.  The first part of this unhappy tale seems to have played itself out as usual. 

 

 

Bottom Line: The question remains, how badly will the markets punish investors who fled to the safety of bonds?