Are Investors Running Out of Safe Havens to Put Money?
Market turmoil has investors looking for safe-haven plays.
Strategists worry that rising rates will hurt investment-grade bonds.
Amid all the challenges facing the markets — Greece, Facebook, JPMorgan — investors face an even larger potential problem: They soon could be running out of traditional safe havens for their money.
Much has been made recently of how goldno longer offers its traditional buffer against financial turmoil, with the yellow metal in a sharp pullback since early March.
But some strategists are beginning to worry that other places where investors are stowing their money — high-grade bonds, Treasurys and defensive stocks in particular — also could be losing their protective shields.
"The problem is we're seeing safe-haven flows with shrinking instruments into which you can run," says Kim Rupert, managing director of global fixed income analysis at Action Economics in San Francisco. "Once the run for the exits gets started it's going to be an absolute stampede."
The search for safety comes as markets are in daily tumult over the debt crisis in Greece and its reverberations through Europe. The Facebook initial public offering had been viewed by some as a potential market turning point but has failed to live up to its billing. And JPMorgan Chase has struck another blow at investor confidence with the fallout from its $2 billion trading loss due to the so-called London Whale.
All of it has added up to major headaches for investors trying to restore their battered confidence.
Rupert's milieu is Treasurys, which have continued to attract buyers despite historically low yields and indications that the Federal Reserve plans on keeping rates near zero until the U.S. economy shows concrete signs of recovery.
The safe-haven flows of which she speaks have occurred at a dizzying pace, from mutual funds that invest in stocks and into those that are concentrated in bonds. Mutual fund investing is considered a proxy for what individual retail investors are thinking.
In the most recent week, money market funds, where investors stow their cash before deploying it for investment, lost another $5.3 billion and now sit at a post-credit crisis low of $2.56 trillion, according to the Investment Company Institute.
However, equity funds lost $3.56 billion while bond funds gained $7.2 billion, most of which went into taxable bonds.
Rupert worries that once the Fed is forced to raise rates — either because of inflation or economic recovery — those holding Treasurys could get hammered with principal losses. Compound that with the European debt crisis and the burgeoning debt and deficit problem in the U.S., and it makes for a troubling future for government debt.
She thinks "a couple of failed auctions" would trigger that stampede in which investors, "no matter what the price aren't willing to take down one more bit of paper."
"It could just be no sovereign debt instrument is safe and people move cash under the mattress or into cans of tuna fish and ammo," she says. "It sounds very apocalyptic, but this is probably as nervous as I've ever been about conditions."
Jim Paulsen, chief market strategist at Wells Capital Management in Minneapolis, also is concerned about fixed income investing, but for different reasons. The storm he sees coming is in investment-grade debt, which has been issued at record-setting levels and could get clobbered as well in a rising-rate environment.
Globally, companies issued $10.8 billion in top-rated debt during the first quarter, the most ever for that point in the year and a 69 percent increase over the same period a year ago, according to Dealogic.
For Paulsen, the danger is economic growth in the U.S. will cause the stampede, which will overcome investors who have been too conservative in their allocations.
"They're paying up for the privilege to sleep well," Paulsen says.
Paulsen sees investors getting snookered by the stampede into investment grade debt instruments, such as corporate bonds, municipals and government agency securities. He fears there will be a steep price to pay once rates start to rise and principal evaporates.
"The biggest story of real risk is high-quality bonds," he says. "I just wonder how much of the premiums could come out of those confidence-builders in the next three years if people decide we're in a recovery."
'You Could Have A Really Bloody Year'
In that scenario, the Fed has to raise rates to control growth and inflation, eroding the value of low-yielding safe-haven bonds such as investment grade corporates and highly rated municipals, as well as defensive stock positions in consumer staples and utilities.
"You could have a real bloody year in those areas, like 1994, like 2004, when things geared up and attitudes improved and the fixed income part got their heads taken off," Paulsen says. "They're not willing to go to lower-quality corporate or municipals because of their perceived risks. But now they have absolutely no buffer to the sense that the recovery is normalizing."
Paulsen says he recommends investors stay diversified, but with an allocation toward Treasurys that is smaller than normal.
"In essence, over the course of 30 years we've taken the high-quality fixed-income market from a high-income low-price marketplace and essentially turned it into a zero-coupon marketplace," he says.
Falling somewhere in the middle of the debate, but with similar fears over fixed income, is Marilyn Cohen, president of Envision Capital Management in Los Angeles.
For Cohen, the concerns are practical: Investors need income now and investment-grade bonds simply don't provide any.
"There's no yield," she says. "The bigger danger isn't inflation, it isn't the Fed. It's everybody that's in the bond fund pool."
That demand for fixed income is creating something that may not have formed a verified asset bubble yet, but is troubling in that nothing seems to deter investors from buying bonds.
"It works as long as it works and it certainly has worked very well since the culmination of the credit crisis," Cohen says. "But there was a lot of wiggle room looking back as far as pricing and yield. But now the yields are so low that risk vs. reward is getting kind of dicey."
She instead is directing investors into lower-grade bonds of companies that may not have sterling ratings but have solid prospects and pay higher yields.
The stock market has stumbled lately but has been on a strong run overall since a summer correction in 2011. Bonds, too, have been solid but have slowed as well even in the face of the stock pullback.
The iShares iBoxx Investment Grade Corporate Bond fund , an exchange-traded fund that tracks the sector, had been on a straight upward trajectory since the late 2008 depths of the financial crisis. But the fund has stumbled over the past three months and could be showing signs of at least some low-yield weariness.
"Portfolio managers are trying to search and seek out a modicum of yield," Cohen says. "It makes it much more stressful on individual investors."