Since the financial crisis of 2008, central banks around the globe have been working to jumpstart economies and stock markets. The main tool has been “quantitative easing” or QE–a monetary policy of purchasing government securities or other securities from the market in order to lower interest rates and increase the money supply.
While the US Federal Reserve has (at least for now) ceased its quantitative easing operations, it still hasn’t been able to return interest rates back to normal levels or reduce its balance sheet back to its former size. Japan has maintained QE at approximately 15% of its GDP for some time and has hinted that it may escalate it in the near future. In March, the European Central bank (ECB) increased its own QE program by roughly a third.
These QE programs have, in some cases such as in Europe and Japan, created negative interest rates. The ECB now “charges” a negative interest rate of 0.4% for banks that borrow from the ECB. This means that the ECB is actually paying banks to borrow money.
Weekly Poll Question:
As interest rates fall, the price of fixed income instruments rise. Such that some market experts believe there is a bubble in the global fixed-income market. Hearing what the “experts” think, we decided to pose the question to our readers, who are primarily individual or retail investors.
So last week we asked our readers:
Do you believe that any of the following global fixed-income markets are in bubble territory?
And here is what they said:
- A: High-yield bonds
- B: Investment-grade corporate bonds
- C: Sovereign bonds
We were a bit surprised that the top answer, with 39% of the 1,438 respondents as of 6:30 a.m. on Sunday, October 16, was “I don’t know.” Also, we appreciate the honesty of our readers.
However, it’s important not to gloss over those results. Our readers tend to be older and in many cases are already retired. Conventional wisdom over the years has been to increase fixed-income allocations are we get older, supposedly to lower the downside risk of our investment portfolios. However, if there is IS a bubble in the fixed-come market, and the average individual investor doesn’t know about it, that could have a significant impact on retirement portfolios.
In all, 48% of retail investors believe that some segment of the global fixed-income market is overvalued (in bubble territory). This is in contrast to professional or institutional investors. In August, the CFA Institute conducted a similar survey and was the inspiration for ours. The results of that survey showed that 87% of respondents see the bond market in bubble territory in some way.
Among our readers, 21% believe all bonds are in bubble territory. Another 10% see a bubble in high-yield bonds and sovereign bonds, while 7% of poll participants think that only high-yield bonds are over-inflated. However, when combined with other market segments, the percentage of those believing that high-yield bonds or over-inflated jumps to 21%.
In addition, 12% don’t see a fixed-income bubble anywhere.
On the other end of the spectrum, 1% believe that only investment-grade fixed income instruments are overvalued. When combined with other asset classes, this percentage increases to 7%.
Since the Federal Reserve increase interested rates last December, there has been a near-constant debate over when the next increase will come. With every economic report and FOMC meeting, market experts have tried to gain insight into when rates will rise. Against, this backdrop, investors are trying to position they fixed-income portfolios accordingly. Rising interest rates will drive down the price of fixed-income instruments but will increase the income they pay.
To get a feel for how investors have been managing their fixed-income investments, we asked this special question last week:
If you are invested in fixed-income instruments, has your exposure/allocation changed over the last year? If so, how, and what was the motivating factor?
In all, 138 readers responded.
Out of the 138 respondents, 5.8% (8) said that they are not invested in fixed-income instruments, whether that be individual bonds or fixed-income mutual funds or ETFs.
Of the 130 respondents that do (or did) invest in fixed-income instruments, slightly more than 46% said they have no changed their allocation in or exposure to fixed-income instruments. Another 23.8% said they have decreased their allocation/exposure over the last 12 months, while 14.6% said they have increased their allocation or exposure to fixed-income instruments over the last 12 months.
Here is a sampling of the responses:
- “Allocation changed? Yes. Jim Cloonan’s book, “Level 3″, altered my thinking.”
- “Although I have mistrusted fixed income securities for several years, I have not sold my fixed income mutual funds. Rather, I have stashed my cash that would have gone into fixed income in money market accounts to maintain the desired allocation to equities.”
- “Exposure continues to decrease as continued low interest rates are giving way to higher-yielding dividend paying equities. Fed’s eventual raising of interest rates should be on a very gradual basis and will continue to support stock prices as investors continue to rotate out of lower yielding fixed income instruments to equities paying higher yielding dividends.”
- “Even if the Fed rate increases, there is so much demand for American fixed-income that I don’t believe it will all come unraveled in a rush at the next increase. Stocks, on the other hand, could tank at any time, as they mostly are not considered “safe-haven” investments. Since stocks currently look overvalued (historically speaking) they are not as attractive. Of course, with interest rates so low, who knows what fair valuation even IS right now?”
- “I’ve reduced my exposure to better reflect the role of my pension and Social Security in my portfolio.”
- “Yes, I increased the amount of bonds and preferred stocks. My strategy was to lower exposure to common stocks and increase the others with the hope of reducing risk/volatility. I am retired and started with 80% in stocks, so a little reduction seemed prudent.”
- “Yes [I have lowered my exposure]. No return for cash flow and corporations continue to call bonds. Good for them, unfair to me. Switched to dividend-paying stocks. May never buy a bond again. Rotten investment in today’s market.”
Everybody has an opinion! Why not give us yours? Participate in our weekly member poll, updated every Monday, and see the results online at http://www.aaii.com/memberquestion.