The Tipping Point

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di Finanza Operativa 23 Maggio 2018 | 13:30

by Swiss Financial Consulting   

     It has been suggested that a 3% yield on ten-year US Treasury bonds (10s) is a sort of magic number that indicates that one should start shifting from stocks to bonds. Opinions vary from 2.85% up to 5% as to what the percentage should be, but one thing is clear. The higher bond yields rise, the more the shift from equities to fixed income will become pronounced. The traditional portfolio distribution of 60% fixed income and 40% equities practically had to be abandoned because of ZIRP and NIRP, which made it extremely difficult for bond fund managers to acquire new issues while the low-interest environment pushed up prices for previously issued bonds with higher interest rates.

         The problem now facing investors is that as the Fed raises the basic rate, at a certain point stock prices are going to react and not only stop rising but will probably fall. The more money that goes into fixed income, the less that goes into stocks. Of course if central banks keep buying stocks, and the BoJ and SNB have already bought a lot, then this premise will be invalid.

         In the normal course of events, however, investors will have to decide for themselves when they will start going back to fixed income securities. If they wait until fixed income returns reach very high levels, they may find that the prices for their stocks have fallen and that they have taken losses that could have been avoided by selling earlier. On the other hand, selling equities at the present time might mean missing out on further stock market increases, and FOMO (Fear Of Missing Out) is a motivating factor that keeps investors in the market.

         Furthermore, selling stocks early at high prices and acquiring bonds when interest rates are rising could result in severe book losses for the bonds as yields climb and bond prices fall. Given that the Fed will probably opt for two or even three interest rate hikes in 2018 and continue with this policy into 2019, thereby adding one hundred basis points to the base rate, it would make sense to hold off switching to bonds. Credit will tighten as the Fed draws down its balance as planned while at the same time the Treasury has to raise one trillion to cover the deficit. So it could make sense to wait before making a move but not too long.

         A plausible defensive strategy could be to begin selling high-priced equities and gradually shifting to bonds while holding temporarily a higher proportion of cash in the portfolio in order to take advantage of the future issue of bonds with higher interest rates. If only one knew when the stock market would start moving sideways or head south! Play it safe and take profits.

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