When the first U.S private equity firm to go public—The Blackstone Group LP (BX)—did so in 2007, I felt that tug: “These are smart investors. If they are willing to share equity with the public, monetize their equity—and spread the risk to investors; is it an equity market top?”
I am getting that feeling again when it comes to bond yields, the barrage of headlines about gold hitting new highs and the rise of equity indexes. Almost always, there is opportunity elsewhere when one asset class feels top heavy, but I am wondering what advisors feel is the prudent route for diversifying assets in this environment.
Treasury, hold my money, please
Will the 10-year U.S. Treasury hit a record low sometime soon? I have no crystal ball. But as a market practitioner and observer for the past 30 years, I have noticed a few things.
Typically, U.S. Treasury securities get bid up in price and the yields fall when folks are expecting trouble, as U.S. Treasury securities are still the safest haven around. But the quantitative easing and other “accommodation” programs that the Federal Reserve discussed in the minutes of its Sept. Federal Open Market Committee (FOMC) meeting (released Tuesday), are intended to impact yields, as well. What does it mean for advisors and their clients when the yield on ten-year Treasury flirts with new record-low yields just as some equity indexes climb toward post-crash highs?
Gold, representing commodities, is considered an inflation hedge and something of a haven when equities crack, but it is extremely volatile, as we all know. It is being included as an asset class in many portfolios as a diversifier. At record prices, when does a bubble distortion in the price of gold
nullify its value as a diversifier and inflation hedge?
No consensus on bonds
Monday’s Wall Street Journalnotes that views on investing in Treasury securities and equities are diverging, with Goldman Sachs’ strategist saying “the Treasury rally has seen its peak.” This view was buttressed by Warren Buffett (who, let us remember, rescued Goldman in 2008), indicating that buying bonds at record low rates was a “mistake,” according to the article. I agree, although I am uncomfortable buying equities at these levels, too. I was more comfortable in March 2009 with a 6,700 DJIA, but that’s a blog for a different day.
Other investors in the Journal article take a different tack, saying that there’s room for Treasury securities to rally further.
Some investors are reported to be reaching for yield in junk bonds and mortgage-backed securities. A report on Oct. 7 inThe New York Timesquotes a key high-yield bond player stating that, for junk bonds, “it’s undeniable that these are the best years that anyone has seen in their career.” What kind of alarm bells should that ring for prudent advisors?
When Mexico sells a $ 1 billion worth of 100-year bonds (trading at a yield of about 5.7% on Oct 7, according to Bloomberg), you have to ask what the next move in yields will be. All of this seems to indicate that we are at a decision point in markets and investing.
Mohamed El-Erian, Pimco’s CEO and co-CIO, wraps it all up in his commentary Wednesday in The Financial Times. He notes that the Fed is “in policy experimentation mode,” which, of course, adds a level of uncertainty to the markets. Pimco indicated earlier in 2010 that it was a buyer of U.S Treasury securities.
While most experts don’t expect to see bond yields jump up immediately, 10 years is a long time. What happens in 2015 when the 10-year Treasury, bought in 2010 at a 1.5% yield to maturity, lurks back to haunt a portfolio? What about that Mexico 100-year bond when rates tick higher? Will clients who remain in Treasury securities say: “I’m just glad to get my principal back,” after the junk bond bubble bursts? And is reason, alone, enough to persuade clients to stay the course you’ve set with them?
There’s a reason why the 100-year railroad bonds issued in the 1800s are prized by scripophilists. The question today is: Do new 100-year bonds belong in a frame or in a portfolio?