In the month of November, we have seen a reversal of the long term trend of flows into bond investments. The chart below reflects cumulative flows of assets into equities/stocks (black line) versus flows into bonds (blue line). As the data shows, since the severe downturn of the equity markets in 2008, fund flows into bonds have been significantly higher than flows into equities.
This is despite performance that has generally been favorable to equity versus bonds. During the last five years, US equity performance (based on the S&P 500) has had a 15.9 percent annual return compared to International equities at 3.8 percent and US bond performance at 2.3 percent. Clearly, investors have remained cautious of equity markets post the financial crisis, and have preferred the relative stability of bonds despite the lower return rates.
As the chart below reflects, this trend has shown some recent signs of change. According to data from EPFR Global, bond outflows for the week ending Nov 16th, 2016 were the largest in over three years. The outflow trend has continued in recent weeks as rising rates have had a negative effect on price performance for bond funds and ETFs.
If interest rates continue to rise, as we anticipate, prices on existing fixed income/bond investments tend to fall. If investors see prolonged declines of fixed income prices, it is likely to accelerate the trend out of fixed income and into equity. This would have a positive effect on equity markets as increased demand should increase the price of stocks.
Historically, fixed income/bond investments have been less volatile than the stock markets. That doesn’t mean, however, that bonds cannot lose value during certain periods. As we look to 2017, we anticipate a rising interest rate environment, and bond investors should expect low total returns with a possibility for slightly negative returns. Despite the lower expected returns, we continue to believe that bonds should remain as part of a strategic portfolio allocation due to their diversification benefits and lower volatility.
To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222