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The Shift from Bonds to Equities

By Bruce Vanderveen on March 13, 2013

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On July 25, 2012, the benchmark US Treasury 10-year note’s yield fell to an all-time record low of 1.38 percent. No one rang a bell, but from that day on bond prices have trended down as yields trended up.

The 10-year note now yields over 2 percent. Investors are slowly realizing that, after 30 years, the era of rising bond prices may be over.

What finally killed the 30-year bond bull? Well, last summer both the US Federal Reserve and European Central Bank indicated they would “do whatever is necessary” to shore up sovereigns and large international banks. The Bank of Japan is now taking a similar stance. It all adds up to a flood of paper money into the world’s major currencies.

Overseeing the easing: the US Federal Reserve. Most Americans are not aware of it, but the Fed not only injects money into US banks but also it is—to the tune the tune of hundreds of billions of dollars—bailing out European banks. What will banks (both foreign and domestic) do with all this cash? Some of it is starting to flow into the equity markets.

Bondholders’ Growing Concern

This seemingly never ending flood of money from central banks is beginning to worry investors. They realize that the continual injection of money (in the form of quantitative easing, or QE) into large banks may help save bondholders from default but it will, sooner or later, lead to currency debasement, rising interest rates, and inflation.

At $37 trillion, the US bond market is more than twice the size of the country’s equity markets. Worldwide bond markets are $100 trillion or more. Even a small shift from bonds to equities will give equity markets a big boost. This likely explains the recent rise in stock markets—despite poor economies.

We are now starting to see a shift of capital out of sovereign bonds (European, Japanese, and US) and into equities. Look for this trend to continue and possibly accelerate in 2013.

The Search For Safety

Bond investors are different from equity investors. They look primarily for safety and secondarily for a predictable income. Historically US Treasury, muni, and investment grade bonds have been instruments of choice for safety-seeking investors. This will change.

Think about it. Which would you rather invest in: Heavily indebted governments that continually print money, or great international companies that are solvent with real assets and cash flow? Many money managers agree and now recommend switching from bonds to equities.

What will the new “safe” investment be? It is hard to say, but initially money leaving the bond market will likely flow into highly liquid US dollars—the world’s reserve currency. US dollars can readily be used to purchase other non-printable assets such as stocks, real estate, and commodities across the world. So it is not surprising that both the U.S. dollar and equities have been rising … as bonds have been falling.

Surging Equity Markets, Poor Economies

Can equity markets climb in the face of a weak economy? They certainly can. Look at what happened from 1932 to 1937: stocks nearly tripled off 1929 crash lows, even as the world sank deeper into the Great Depression. Capital will flow to where it is treated best and at this point equities are beginning to look safer than bonds.

You can benefit from the flow of capital out of bonds and into equities with SPDR Dow Jones Industrial Average (NYSE: DIA), SPDR S&P 500 (NYSE: SPY), and PowerShares QQQ (NSDQ: QQQ). These exchange-traded funds (ETFs) hold diverse holdings of many of the world’s strongest companies.

Look for, at least in the short term, the US dollar to continue to rally. This bodes well for the bullish US dollar ETF: PowerShares DB US Dollar Index Bullish (NYSE: UUP). Because a strong dollar usually means weak precious metal prices, consider shorting the latter. Consider ProShares UltraShort Gold (NYSE: GLL) or ProShares UltraShort Silver (NYSE: ZSL).

At this point capital is beginning to flow out of sovereign (and other) bond markets as investors start to lose faith in the ability of governments to safeguard their savings. It’s flowing into equities, real estate, and other tangibles. The easiest and safest way for investors to participate is through the ETFs mentioned above.

Markets rarely move straight up (or down). Look at corrections as buying opportunities. Equity markets have been strong recently so a correction is likely, but the predominant move in equities is bullish.

What did you think of this article? Please post your comments below!

Bruce Vanderveen is a Florida-based freelance writer.

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