Looking over the economic landscape is not very comforting these days. As I drive around, I hear ads that you can get a mortgage for “more home than ever” now. Really? Wasn’t the lesson of 2008 that we need to figure how much someone can safely afford? Getting more house than ever is probably as bad an idea now as it was in late 2007. Living within your means is a winning strategy. Living above your means never ends well, though we seem to be entering a new phase of pushing those limits until they snap us back to reality.
In the investment world we see a similar appetite for risk. Money which has been wasting away in money markets since 2008-2009 is now flowing into stock funds. Stocks appear to be somewhere between fully valued and overpriced, but…the same people who were unwilling to invest over the past 4 years are now taking the risk of owning stocks.
At least as alarming is the rotation from safer to riskier bonds. Investors seem to take this change as not affecting their portfolio risk (i.e. bonds are in portfolios for safety and low correlation to stocks). This is a large mistake and one that may come home to roost at some point in coming years. In general, high yield bonds have a positive correlation to stocks. So, when markets fell precipitously and US Treasuries rose during the financial crisis, high yield bonds fell in value at warp speeds.
We are not opposed to owning higher risk bonds at this point. However, investors need to understand what they own and how it could impact them in the future.
By Ted Schwartz, CFP©