I was with a CIO the other day and told him that if I could work on only one investment issue I would try to figure out the implications of an end to the thirty-year fall in interest rates.
You have undoubtedly read lots of stories about the risks in the fixed income market. A year ago I wrote about bad bond math. More recently, I have warned of the risks of complacency with high yield bonds and what appear to be boring stocks that are masking themselves as the new bonds of the day.
The flood of money into yield vehicles will very likely lead to tears, as pointed out in a recent piece by Josh Brown. Reaching for yield has taken many forms and has become ingrained in the habits of investors; check out the list of vehicles from David Merkel for starters.
You can see the returns above for ETFs representing some of the favored yield plays (plus the S&P 500 for comparison) since April of 2009, when AMJ started trading.
But these are the obvious ones (although many novice investors might not think of preferreds and MLPs as interest rate vehicles). The real question — the big question — is what will happen that we aren’t expecting, across all asset classes and for all the different types of security issuers.
If . . . . Yes, let’s deal with “if,” since you’ll hear people say that rates could flatten out or go lower still. That’s absolutely true, but no one really knows. The job of an investor is to figure out the range of possibilities, take a stab at the probabilities, and consider the potential impact. That’s good process.
If, after thirty years of the wind blowing almost always in one direction it starts blowing in another direction, maybe violently so, it will engender the mother of all paradigm shifts. If you think you have an idea of all the surprises that will be in store, you don’t. But it would do you good to spend part of your time now trying to figure them out. (Chart: Bloomberg terminal.)
If you are looking for a simple description of what an investment professional has to do, I’d offer this: analysis plus communication. The latest installment of a series on equity research focuses on that formula, the second part of which is chronically deficient throughout the business.