Despite a continuous diatribe by soothsayers warning that the U.S. markets have run too far, too fast, the stock market continues to climb higher. Every dip is met by buyers eager to own stocks and it looks increasingly likely the next stop on the S& P 500 Index is 1,200.
That is neither a unique nor particularly brave call. It is, in my opinion, the path of least resistance. Clearly there is a hunger for dollar-denominated assets by overseas investors. Spooked by sovereign debt problems in places like Greece and Portugal, foreign investors have temporarily lost their appetite for their own currencies and stock markets, including the once-red hot emerging markets. Given their concerns, they prefer putting their money here where, despite high unemployment and a slow-growth economy, we as a nation aren’t in danger of defaulting anytime soon as a nation. But foreigners, I suspect, aren’t the only investors that are eyeing the stock market with renewed interest.
“Bonds have seen their best days,” warned Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Company (PIMCO), this week. He went on to say that the prospect of a strengthening economy and rising interest rates creates an argument for under owning bonds going forward. So where does Gross suggest you put your money? He is putting his money where his mouth is and you guessed it—buying stocks—which is why PIMCO began offering stock funds in December.
That can’t be good news to the retail investor who only last year plowed $90 billion into bonds. However, not all bonds are bad. In a rising rate and growing economy kind of scenario that lies before us, corporate bonds, junk bonds and other non-Treasury debt securities actually do quite well, at least to a point.
In a recession, bond holders flock to safe U.S. Treasury Bonds and shun company debt because they are afraid of default. As the economy recovers, investor’s fear that a particular corporation won’t be able to pay it’s debt lessens and prices of their bonds actually go up (and yields decline) despite rising interest rates.
Of course, as the economy gets even stronger and interest rates rise high enough, there will be a point when all bonds underperform but that will happen in stages. So don’t go dumping all your bonds right away. Certainly, your U.S. Treasury bond funds are living on borrowed time. I would definitely be selling those. As for the rest, there may actually be a period in 2010 where corporate and high yield bonds outperform the stock market. We will write more on that subject when the time comes.
As for this week’s market action, other than tacking on a few points to the Dow, the averages largely remained in limbo. On both Thursday and Friday bulls were thwarted as the averages first made new yearly highs only to sell off by the end of each day. That is to be expected whenever the markets reach new highs or key resistance levels so I’m not bothered by a bit of consolidation here. I still believe the markets go higher.