Thursday April 19, 2012
by Jim Oberweis, Jr., editor The Oberweis Report
Importantly, we believe something bigger is happening here: the pendulum is starting to swing back to equities after favoring bonds for over a decade.
There are a number of reasons to be optimistic about equities, including attractive valuations, an improving U.S. economy, lean and cash-flush corporations, and a well-capitalized banking system.
The biggest reason of them all: equities are the contrarian play. Equities are hated. So while the S&P 500 Index has doubled off its low in early 2009, we believe there is more to come over the long-term.
Investors have piled truckloads of money into bond funds in recent years because they consider them safer than stocks. But are bond funds really safe? Not necessarily.
Interest rates have been going down for so long (the U.S. 10-year yield has declined from 6.8% in January 2000 to a low of 1.7% last September) that people forget there is an inverse relationship between rates and bond prices.
When U.S. interest rates eventually head higher (and they will), bond prices will decline, meaning U.S. bond funds are likely to post losses.
Unfortunately, most investors do not understand this relationship. Surprisingly (or maybe not so surprisingly), a comprehensive survey conducted by FINRA found that only 21% of respondents understood the relationship between bond prices and interest rates.
The vast majority of average-Joe investors don’t know that bond funds are likely to post losses when interest rates rise.
So while the S&P 500 Index has doubled off its low in early 2009, we believe there is more to come over the long-term.
There’s a ton of money tied up in fixed income that will, sooner or later, make its way back into equities as investors see equity returns increase while bond funds likely succumb to losses.
When bond fund investors begin to cry uncle, there will be plenty of rocket fuel to propel equities higher still.
In the meantime, can U.S. stocks see a 10-20% correction at some point this year? You bet. Corrections – some as great as 35% — were common during the 1982-2000 bull run.
But a wise investor will be greedy when others are fearful and use any pullback as an opportunity to get in front of the next great bull market for stocks. After all, in our view, the great bull market for bonds is over.
Learn more about this financial newsletter at Jim Oberweis Jr.'s The Oberweis Report.