Investors Run to Bonds as Anxiety Builds

American investors are in risk-aversion mode and are not likely to get out of that funk until interest rates start rising. That’s the fundamental conclusion of Morningstar Senior Stock Analyst Greggory Warren.

According to Morningstar, investors pulled $4 billion out of domestic equities funds in May and another $6 billion in June, with most of that cash funneled directly to defensive bond funds, Warren said.

“People’s attitude towards money and investing has changed from what it was 10 years ago," he said. "Back then, they were conditioned to ride out market downturns or to jump out and then jump back in on the next upturn. Now they are getting out of equities on downturns and are not so quick about getting in on upturns.”

He also said that beyond the "Average Joe" retail investor, institutions are shifting more into bonds.

“They’re investing in equities and in alternative investments,” he said, “but even they are slower about getting into equities than in the past. There’s more of a capital preservation mindset among institutional fund managers.”

Warren said after what he witnessed in 2009 and 2010, he was “surprised” to see investors move heavily into equities in the first few months of 2011, especially given the unrest in the Middle East and the serious natural disasters in the Asia-Pacific region -- particularly the Japanese earthquake, tsunami and resulting nuclear plant meltdowns.

But he said since April, the struggling U.S. housing and employment markets, rising oil and gas prices and the impending end of the Fed's second round of quantitative easing (dubbed QE2), have prompted investors to return to their cautious approach.

He notes that while the S&P has risen over 8% this year, it is down close to 5% since early May.  Moreover, bond inflows over the first two quarters have totaled more than $100 billion.

“Should this trend persist through the second half, we could see a third-straight year with investor inflows into taxable bond funds in excess of $200 billion,” he said.

Money is also flowing into tax-exempt muni bonds too, Warren said, after a brief period of outflows earlier in the year.

This phenomenon is no short-term trend, according to Morningstar.

Warren said that during 2009 and 2010, investors poured a record $500 billion into taxable bond funds. And if present trends continue, they could put another $200 billion into bond funds this year.

Warren said the movement into bond by investors was beginning to resemble the attitude towards real estate in the last decade. “You have people saying now that 'bonds don’t go down' just like they used to say about housing.”

Asked what he thought it would take to change this attitude, noting that the price of bonds fall as yields rise, he summed it up by saying, "a rise in interest rates.”

 

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Money Management Executive
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