Sunday, March 1, 2009

Why You Shouldn’t Move to Bonds

Most investors like to put their money in something that has done well. Most don't put their money in something that has done poorly. The last 10 years gives us a stark portrait of what's done well and what hasn't. And we're starting to see a major psychological shift in where investors want to put their money as a result.

In short, people seem to have had enough of stocks. They're moving into bonds. Oddly, and as strange as it sounds, this inflection point just might be the turning point for stocks. Put another way, investors as a group just got the last 10 years wrong. Thinking in contrary fashion, they may get the next 10 years wrong as well.

Stocks, as a group, have not done well now for 10 years. As of yesterday, if you had put $10,000 in the S&P 500 10 years ago, you would now have about $6,200 ― a loss of 38%. And it's worse than that considering the effects of inflation.

If you look at bonds, they've done much better. The Merrill Lynch U.S. Corporate Master index, a measure of high-grade debt, for instance, has gained 58% in the last 10 years.

You can hear the gears turning. Stocks have not done well, investors reason, and bonds have done much better. Therefore, buy bonds.

That's what they are doing in large numbers. Here are some telling quotes from a recent Wall Street Journal article. From a manager of $185 million in individual accounts:"I think a lot of investors have just had it with the equity markets… The baby boomers are saying, 'I'm too old to make up these losses… I'm not going to risk it."

Another, who has $414 million in assets under management:"The credit markets are the market, and the stock market is a sideshow, period."

One more, from a money manager of $900 million in assets:

"The debt markets seem pretty well understood, while the outlook for equities is still murky."

Even the Journal itself waxes on about the simplicities of bonds. You only have to figure out if the company can meet the minimum payments of the bonds. You don't have to worry about figuring out growth rates or what earnings per share may be. "With no end to the recession in sight," the Journal sighs, "logic for buying equities is wavering."

(If you're like me, you're probably suspicious of someone who repeatedly says "equities" when the plain-old word "stocks" suffices.)

So the stock market has been cut in half…and NOW these advisers are all cheerleaders for the bond market. Already this year, bond funds have added some $15 billion to their assets. Last year, investors took out nearly $200 billion from their stock mutual funds.

Going with what's worked well in the past sounds reasonable, but investing is an odd thing. It's not like many other areas of life.

If you get a bad haircut after going to the same barber for a few times, you stop going to that barber and find another. You don't stick with bad barbers and you don't go looking for bad barbers.

And if you get a good meal at a restaurant, you keep going back. You don't worry about the restaurant getting too popular. You don't look for a dive where hardly anyone goes, thinking you'll get a better meal.

Investing is almost the exact opposite ― which is one of the things that make it so hard. The best way to make a lot of money in stocks is to buy something good that few people seem to want. Then you sit on it, and when people get excited about buying it again, you gladly sell at a premium price and make some multiple on your initial investment.

All the greats made most of their hay in just this fashion ― John Templeton buying up small-cap stocks in the Great Depression… Warren Buffett picking up The Washington Post and adding shares of GEICO in the depths after the 1973 market tank…and on and on…

The best deals become available during times like now. That much is a fact. I'm not saying it's easy. I'm not saying all stocks will rise. Some of them are going to go to zero. Some of them are never going to come back. But some of them are great businesses and have great assets that will certainly come back at some point.

I know it can be tough when stocks you own are down so much. But looking ahead, I can't help but be more optimistic…

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