I have previously expressed the opinion that mutual fund investors with at least a 1 or 2 year perspective should continue to be leery of maintaining a large majority of their investments in stock funds since it is possible that the upturn that would create a better environment for stocks may take far longer than most people expect. In fact, I have been recommending a near 50% portfolio position in bonds over the last 6 months beginning on Sept. 15, 2002 in Newsletter 68. This strategy has worked well: Since that date, the 6 month returns on the bond funds I have been recommending have averaged over 6% or over 12% when annualized. The corresponding return on a typical S&P 500 index fund has been around -5.7% or worse than -11% if annualized.
But suppose you still have the majority of your portfolio in stock funds and are now contemplating switching a large percentage or even a 100% switch into bonds? Or suppose you are one of those sitting on cash and wondering if bond funds might not be a better place. Is this a good time to make either of these moves?
At this juncture, I would be careful about committing large sums to the bond market (although much more modest switches especially if you are still over-allocated to stocks still make sense), at least until we see how the following events play out:
If the Fed lowers rates on 3-18, this would belie their previous stance that the economy seems to be gradually recovering without the need for further cuts. A drop in rates would be perhaps an ominous sign that even the Fed recognizes that we might be in the throes of a more serious economic situation than they have chosen to acknowledge before.
If war does break out, a potential bond investor may, as the pundits suggest, see a quick reflexive upswing in stock prices. This could have the effect of temporarily taking money out of bonds into stocks. But the true effect of any war on stock prices probably won't be known for at least several weeks after the onset. Therefore, if a gain in stock prices proves only fleeting and investors again continue to focus on the weak economy, it will also make sense to expect bonds to continue to do well.
A third factor that may also bear watching may already have started to show itself in longer term performance trends. One of the best proxies for the strength of the bond market is the performance of long-term treasuries. Over the last 3 years, for example, Vanguard's Long Term Treasury Fund (VUSTX) has returned 12.7% annualized, or about 1% per month. Since end of Sept., however, a period nearing 6 months, this return has been even less than 0.5% per month, or less than 6% annualized. This may be showing that in spite of all the economic weakness and geopolitical concerns favoring bonds over this recent period, long term bonds are starting to fade a little as strong performers. If sustained over the next month or so, I think this may be telling us that the best returns for many bonds may well be behind us.
Even in the unlikely event that all 3 of the above factors turn out not supporting switching over funds to bond investments at this time, would this mean then that stocks would therefore be a better bet than bonds over the next year or two? The occurrence of these events would certainly help level the playing field although I suspect that stocks may not do much more than meander (although with considerable volatility) until the country returns to a more stable and optimistic frame of mind. This may not occur until a more promising economic and overall safer world situation re-appear. This in turn may not occur, in my opinion, until the politicians in Washington, both Republicans and Democrats, can give us a realistic agenda for winning not one but two wars: a somewhat sickly economy as well as the return of the world once again to being a relatively safe place without the ongoing threat of more than one crisis hanging over our heads. Unfortunately, this may indeed take at least several years the way things appear to be shaping up right now, which is something that many people may not be factoring in as they make their current investment decisions, either actively, or indirectly, through no action regarding their investments at all.