The end of 2012 brought some promising trends in the market for equity investors. Investors were cautious with the fiscal cliff approaching on the first of the year, but the caution didn’t yield any immediate damages as the first of the year approached, and investors are optimistically turning to the approaching months with bullish expectations, marking the onset of the “great rotation,” a period of growing investor confidence in the market, characterized by a reallocation of funds from fixed income assets to equity. This happens because as yields from bonds go down, people tend to go back to equities.
“There’s a gradual increase in confidence,” said Ayaz Ebrahim, chief investment officer for Asia ex-Japan at Amundi Asset Management, one of the world’s biggest asset managers, managing roughly $1 Trillion in assets. And while he explained that the investor confidence hasn’t turned into a flood, the trickle of confidence we saw in 2011 is flowing steadier and with more consistency, riding the wave of 2012; the optimism for seeing greater gains via equity is building. “The search for returns is much stronger now.”
Ebrahim predicts that equities will outperform fixed income over the next 12 to 18 months as asset managers and retail investors chase bigger returns.
This kind of prediction is a good thing for anyone who is investing in the market, whether you prioritize fixed income or securities; and along with the rising global stock markets, it indicates that now is the best time to begin re-evaluating your portfolio for equity holdings. As the market trends shift to even more equity-friendly market movements, equity investments stand to see healthy returns.
The reason this happens is that investor expectations are often highly correlated to future market trends. In laymen’s terms, this means that if you expect Apple to go up, the rest of the market usually thinks the same. This shift in demand will then increase the price of Apple’s stock.
Does 2013 look to be a promising year?
A number of experts are forecasting favorable trends in equity investing that signal favorable investor sentiment, which also indicates the shift from bonds to equities. For example, in Canada there are asset managers who believe that 2013 will be the year that investors who retreated from the market after being burned by the 2008 financial crisis will return to equity-linked products due to rising global stock markets.
“The good news is I think people are relatively bullish, advisers are relatively bullish,” says Sadiq Adatia, chief investment officer at Sun Life Global Investments, a unit of Sun Life Financial Inc. “That is probably why we’ve had a good start to the year and I think that momentum is going to continue on.”
A survey done by Sun Life finds that 70 percent of Canadian financial advisers are optimistic about the S&P 500 in 2013.
Savita Subramanian, head of U.S. equity and quantitative strategy for BofA Merrill Lynch, predicts that the S&P 500 will end the year for 2013 at 1,600, eclipsing 2007 highs, which bodes well for investors who either stuck it out through the 2008 recession, or who sold high and bought low.
Trends Indicate a Shift from Bonds to Equity Investing
The fact of the matter is, we are investing to get the highest return on our dollar. 2013 may be that time to dive in before everyone else does.
Michael Hartnett, chief investment strategist for BofA Merrill Lynch, said in a December 2012 conference call that the next 12 to 18 months will provide low yields as the Fed’s economic policies will stop deflation, positively impacting gains in the labor market, which means that equity investments could soar, he added.
In a survey by Investor Economics, we learned that in 2012, asset portfolio managers prioritized fixed income (aka bonds, CDs, CDOs, MBS, and treasury bills) in their clients’ investment portfolios, putting 47.2 percent of their clients’ total assets into fixed income holdings. Furthermore, in terms of stocks for their clients, they allocated only 48.5 percent.
This is significant, because before the financial crisis, asset managers used more of a 60 -40 ratio of stocks to bonds when the market seemed strong, rather than a 47-48 strategy in this post-Recession recovery period.
These ratios can also tell us that the level of risk each portfolio manager was willing to assign to their average number of clients. Even though you have riskier corporate bonds yielding higher returns than the treasury bills, they’re often perceived as a less risky alternative to equities. The percentage fixed income holdings often tells you what risk level that you’re having.
For example, I have a very high risk tolerance, since I have a long time until I retire, which means that I have decided that when I make an investment, I’m willing to lose more than someone close to retirement. I prefer a 100% equities allocation as it gives me the benefit of both growth and disposable income (when investing in dividend stocks), plus that’s where I’ve done my homework. Bottom line is: before you make your first stock purchase, you should decide for yourself what your risk tolerance is so you know how much to invest in stocks to begin with, what stocks to invest in, and when to sell.
What are some reasons for this shift from fixed income to equity investing?
As explained in a June 2012 article from the Economist, “Low yields are to be expected in any downturn. When the economic outlook turns grim, government bond prices tend to rise, and thus their yields fall.”
Bond yield = Coupon (interest payment)/Price [^Price = Bond yield v]
This happens for two reasons: “First, during a recession, inflation, the great enemy of bond investors, mostly stops being a worry. Second, a weak economy leads to more corporate failures and falling profits, prompting investors to flee the equity market.”
But now, investors are seeing the overall return of bonds going down, through federal and central-bank policies. Low bond yields are a deliberate strategy used by policymakers to stimulate the economy at a time when they have already cut interest rates dramatically. In America and Britain, for example, the Federal Reserve and the Bank of England have embraced quantitative easing“The Bank can create new money electronically by increasing the balance on a reserve account. So when the Bank purchases an asset from a bank, for example, it simply credits that bank’s reserve account with the additional funds. This generates an expansion in the supply of central bank money” Source: Quantitative Easing, Bank of England (QE“The Bank can create new money electronically by increasing the balance on a reserve account. So when the Bank purchases an asset from a bank, for example, it simply credits that bank’s reserve account with the additional funds. This generates an expansion in the supply of central bank money” Source: Quantitative Easing, Bank of England)—the buying of bonds by flooding the markets by printing cash from the Treasury (essentially creating money where there was none before!).
What is so favorable about 2013 for Equity Investing?
Once the shift from bonds to equity starts, early opportunities will go quickly. Today’s general portfolio is skewed towards bonds from the 2008 crisis, but when the structure gets restored to pre-2008 ratios, you’ll see more capital flowing into equities, limiting investors chances to get in at a good price for undervalued stock opportunities.
With the compromise of the fiscal cliff, the market rallied in January. Furthermore, many earnings reports have been beating analysts’ expectations. The benchmark S&P 500 advanced 5.1 percent in January, its largest monthly advance since a rise of more than 6 percent in October 2011, and its best January showing since 1997 when it rose 6.1 percent. The Dow gained 5.8 percent and the Nasdaq rose 4.1 percent.
In a separate report, the Commerce Department said American incomes rose 2.6 percent in January, the biggest increase since December 2004.
A report from the Labor Department showed the number of applications for jobless benefits in the U.S. fell by 5,000 to 366,000 in the week ended Feb. 2. All of these indicators show a rise in consumer confidence, which hasn’t seen a jump for 5 weeks.
It’s time to re-evaluate your portfolio and for you to decide whether your holdings could be re-allocated and if you currently don’t have an investment portfolio, it’s about time to start one. The markets are beginning to gain some traction, albeit tentatively, and when equities do take off soon, you’ll be more likely to see those gains you’re looking for if you act sooner.
As always, do your homework, ask your advisor what strategy is right for you, and keep sharing your experiences with the SprinkleBit Nation!
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