Business | Investment
Pessimistic investors 'put too much money into bonds' during recession
People miss out on best performing stocks that turn up during worst economic periods
- By Denise Law, Financial Times
- Published: 00:00 November 21, 2009
For six consecutive months, investors have shifted money into safer asset classes such as fixed income. But Liz Ann Sonders, senior vice-president of Charles Schwab & Co, cautions against putting too much money into corporate and government bonds.
"During a recession, investors become so pessimistic that they go into bonds, even though stocks outperform them five years later," Sonders said.
In March, when the stock market hit rock bottom, US investors kept 45 per cent of their portfolio in cash, 14 per cent in bonds and 41 per cent in stocks, according to a survey by the American Association of Individual Allocation.
By October, however, bond allocation grew to 24 per cent, a bigger rise than in the period following the Dot.com crash, when investors moved a bigger proportion into stocks.
Uncertainty
These figures appear to indicate that investors remain somewhat reserved, especially at a time when many are still unsure with where the economy is headed.
Sonders attributes the current enthusiasm for bonds to a lack of good news, particularly from policymakers and central banks. She said investors often wait for a clear indication that the economy is improving before they regain faith in stocks. By the time they become confident, however, most have already missed the entry point.
"Investors think; ‘No, I don't want to put my money into the stock market' and wait until there is more good news. But they end up missing a big chunk of the bull market," she said.
"Historically, bull markets are born in the heat of the recession."
Sonders cited two periods in which the stock market produced far greater returns than bonds. In 1935 and 1953, five years after an economic downturn, the S&P 500 provided returns of 33 and 23 per cent respectively, while 10-year treasuries produced 4.6 and 1.6 per cent, according to The Leuthold Group.
Sonders said investors would have reaped the benefits of the market rally had they entered in March, when corporate earnings were at its weakest.
"The best performing stocks take place during the worst time in the economy. Many companies were trading at an average of 17 times earnings, making this period a sweet spot for a surge in earnings growth."
Primary concern
However, Sonders does not dismiss the importance of bonds, citing asset allocation as a primary concern for investors. She said bonds should form a decent proportion of an investor's portfolio, though she warned against becoming too entrenched in one particular asset class.
Sonders foresees a shift from a low-quality environment in which investors took risks in companies with poor fundamentals, to a more high-quality, defensive environment.
However, she said that with the emergence of exchange-traded funds (ETFs), an investor portfolio is no longer just about stocks, bonds and cash.
"Investors are still tempted by commodities and emerging markets. ETFs have also democratised the market, giving investors global access. They will go where the returns are the greatest. Performance chasing is never dead."
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