I have read a couple of recent articles describing individual investors as fleeing the stock market, ostensibly in favor of bonds. No doubt some investors are jittery over the fiscal cliff stuff or the upcoming clash over debt ceiling and spending or maybe even still shaken from the aftershock of the financial crisis.
May I suggest that many have heard all this before? Please understand I am not predicting a market, just sorting through the fog.
In fact the entry and exodus by small investors has spawned the concept of the contrarian view of investing. This is essentially that professional and institutional traders will watch the behavior of the small investor as a class and do exactly the opposite on the premise that the little guy is operating by mob behavior and is always wrong.
That is technically too narrow, but close enough for our purposes.
I took note that financial historian Charles Geisst compares this movement, measured from 2007, similar to the Crash of 1929. I hope he was quoted out of context because the two are apples and oranges. In 1929 only 3 million Americans (2.5 percent of the population) owned stock and they were largely speculators, many of whom got taken for a ride in the manipulation of the markets by a wealthy few. In fact there were just 1,548,000 brokerage accounts at the time.
Largely underrepresented in this current scare is the real change, which took place in 1974 with the Employee Retirement Income Security Act. This act allowed retirement investors to create Individual Retirement Accounts and 401(k) plans among others and provided for mobility of those plans between employers.
At one point in the last decade the percentage of investors in stocks reached 57 percent of working adults. With such massive participation is it any wonder the reallocation from stocks to bonds is measured in the hundreds of billions of dollars?
Rest assured the equities markets are not going away, nor will the natural hysteria tied to personal security for that matter. I think any sound financial manager would tell investors to stay the course, even though the next few months are liable to be sloppy.
I have stated in this column in the past that doomsday pundits know well that they can get people to buy into bad news predictions much faster than good news predictions.
So what about the bond market anyway? Is it safer? Well, on one level, yes. In the event of a default on bonds, which could be triggered by a bankruptcy proceeding or liquidation, the bond investor will be paid out well before the equity investor, for whom there will probably be nothing.
But on the practical side bond prices go up and down, too, normally with changing interest rates. Here we need to focus on the stated rate paid to the bondholder as distinct from the yield to maturity (termination of the bond).
Today, interest rates are at historical lows. If you bought a bond with a 2.5 percent interest rate and rates for similar bonds rose to 5 percent, your bond would have to be discounted in price in your portfolio to yield 5 percent to the maturity of your bond, and your statement from your manager would reflect that lower market value.
Suffice it to say that over the next several years long-life bonds are likely to do worse than they are better as interest rates rise again. In truth, however, many well-structured portfolios have both stocks and bonds.
Of course, you can always take no risk, keep your money under the mattress and earn absolutely no rate of return. That will assure that you will not take a loss of capital, but inflation will erode the purchasing power of that money. So you will lose anyway.
One final thought on an irksome media ploy that itches like a bug bite: Business cycles are not going away. Consider them living, breathing entities that are part of a healthy economic body. We have had 47 contractions (recessions) and expansions (recoveries) of the business cycle since 1796. We will have more. They are normal. They purge weaknesses from the economy and make us stronger and more competitive.
Financial crises we can do without.
Russ Wigh is a professor of business. Email him at rdwigh@bellsouth.net.