Are Stocks Beckoning?

Edmund_Dantes wrote, "As to the question of stocks or bonds, maybe the temporary answer is 'neither.' Professional fund managers would probably seldom be so candid as to suggest there is danger in both (lest investors sell those funds and deprive fund managers of their fees for managing assets). But if rates move up sharply, decimating bond fund net asset values, is it likely that stocks will just shrug that off? More likely, it will portend more expensive borrowing/leveraging costs, and would precipitate a sell-off in stocks too.

"Exhibit A: The precipitous rise in Greek interest rates surely decimated Greek bonds, but it also decimated Greek stocks (which of course compete for investment capital)."

Smclellan is also concerned about what rising interest rates could mean for her bond portfolio, noting, "I anticipate that inflation is going to pick up dramatically in the future and interest rates will rise, which will cause the value of my bond investments to decline in price. For this reason I have sold off bond funds. I have laddered short-term certificates of deposit instead."

TOOOINTENSE has also temporarily retreated to a higher cash position, concerned about Congress' ability to deal with the looming debt worries. "A study of the S&P 500 over the past thirty years shows a disturbing trend of asset bubbles brought on by [former Federal Reserve chairman Alan] Greenspan's 'easy money' policies, and continue today with the current Fed. A chart will show a huge runup since 2008, which looks more like a continuing of the trend.

"With that said, I am moving into a temporarily higher cash position by both reducing bond and equity positions. It is said the market doesn't like uncertainty, and I, for one, am in full agreement with that statement at this time. August will tell what will happen on the U.S. debt issue, and this October might be one to remember. If true, just think of the possibilities when the dust settles!"

Ditto for Pete02, who's concerned about Congress' ability to reach an agreement about whether to raise the debt ceiling. "There appears to be a significant risk that stock markets may experience a major stock market crash, comparable to 2008-09 in severity, within the next two months. A responsible financial advisor whose advice I take seriously has recommended against making any investments until the debt ceiling issue is resolved, and has indicated that a number of investors are quietly liquidating holdings and converting securities into cash in an effort to minimize losses if such a crash occurs, as appears increasingly likely given the grossly irresponsible actions of Congressional leadership."

Messing With the Ingredients
For a broad swath of users, however, maneuvering among asset classes smacks of market-timing, which runs counter to their generally strategic approach to asset allocation.

Saltydog wrote, "This all sounds like market-timing to me. How many people actually sold in 2007 and bought on March 9, 2009? It seems to me that you should stick with your market allocation until your long-term view of the world is fundamentally changed. Incidentally, I know people who sold in early 2009 and went totally into bonds and cash. Good move?"

Glebbb was of a similar mind, noting, "I'm retired with a 40% equity/60% bond allocation; both sides are up 5.5% year to date, so everything is still in balance. I cannot buy more stocks, now, without throwing everything out of kilter, and at these current P/Es, it doesn't seem prudent to load up on stocks. Isn't my planned 40%-60% allocation supposed to mitigate the fluctuation in returns? And, when one side earns more, I think I'm supposed to get back to 40%-60%, not load up one side in anticipation of returns I know nothing about."

Then, quoting Yogi Berra, he wrote, "'Predictions are very hard to make, especially about the future!""

Edmund_Dantes added a Mark Twain quote with the same general spirit. "October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February."

EasyAsItGoes, staying true to his handle, wrote, "I try not to jump every time I hear a loud noise. To that end, I have steadfastly avoided buying freeze-dried (or shrink-wrapped) food for the alleged coming food crisis. I'm pretty much the same way when it comes to investments. I don't panic. My 'core' percentages are always 60% in stocks, 40% in a combination of bonds and a smidgen of convertibles and precious metals. When the situation warrants, I may alter that formula to 50/50 but that is about it."

Molokoeo is similarly mellow, noting that a carefully laid asset-allocation plan shouldn't be upended at the drop of a hat. He wrote, "I haven't changed my allocation between stocks and bonds, nor have I sold my position in gold just because [famed hedge-fund manager George] Soros is selling his. My allocation is designed to meet certain return and volatility goals over time, and messing with the ingredients almost ensures that the cake won't rise. I have a modest position in PIMCO Total Return, and if Gross wants to tinker with that, it's OK with me. But that's as far as I'm going. I think it would be a mistake to do otherwise."

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RetiredInvestor said, "I've recently changed my target fixed-income allocation to about 29% from about 38%. This was more a result of the recent Portfolio Makeover series analysis than the market which in my view has not rewarded credit or duration risk appropriately for some time. I am finding some values in repackaged corporate debt sold in retail CORTS. Yields are much more in line or above underlying company risks as reflected by their public debt pricing. I have also increased my cash component as a result of the runup in equities recently and am awaiting buying opportunities at lower prices. Today I witnessed some correction, but I expect more."

FidlStix is also maintaining a robust equity weighting, with an eye toward scooping up bargains if the market continues to sell off. "As the present sell-off marches--hopefully deep--into correction territory, I'll be looking at adding a consumer-necessary name or two to my stock portfolio. Right now I think toothpaste and toilet paper are better guesses than cameras and computers."

Buying What He's Selling
For other users, they believe the trick to navigating the current environment isn't giving up on bonds altogether but rather recognizing that they fill a valuable stabilizing role in their portfolios and getting smarter about how they invest in them.

Dragonpat wrote: "Bill Gross and the funds he manages have saved my portfolio from becoming too negative more than once now in the last 13 years. My answer is no, I have not increased my allocation from bonds into stocks (30% bonds currently). Several months ago when Gross started dumping Treasuries, I sold the shares in my 401(k) long-term bond fund, which was 100% Treasuries, and bought more of  PIMCO Total Return  with the proceeds. And just to be safe I bought a smaller amount of Jeffrey Gundlach's  DoubleLine Total Return  also. My basic premise is that Bill Gross has the best shot at making money in bonds if anyone can."

Ironically, Dragonpat wasn't the only poster who's buying Gross' fund, not his advice about equities. Ol24601 wrote, "I am thinking that I should move an additional 10% of my portfolio from equities to PIMCO Total Return during the next 12 months (that is, 20% of my total portfolio in the fund). And I hope that Gross gets it right again and finds the way to navigate the mine fields. So I guess I am crazy, but I am planning on moving my money in a way opposite to what Gross suggests that I do, by having it managed by the person who recommends just the opposite. But I appreciate his honesty in making a recommendation that is not in his own financial best interest. "

Mrpcid concurred with the endorsement of active management, noting, "I haven't reallocated as a result of the commentary/noise by Gross and others including Morningstar analysts, but I have moved to all active management for the bond sector of my portfolio. I think it's still important to have bonds, and gradually more of them as I age, but I feel they need to be actively managed by experts.

"Until a couple of months ago, my overall 15% portfolio allocation used to be reflected in my 401(k), which only offers index funds. No more. What was in the bond index fund is now in the plan's cash offering, and all my bond exposure is now through active management in other accounts, where I will continue to invest in  Metropolitan West Total Return ,  Fidelity Intermediate Municipal Income ,  Loomis Sayles Bond , and PIMCO Total Return. (I still have both indexed and actively managed equities.)"

GeorgeBMac, meanwhile, views bonds as the lesser to two evils at this point. "Essentially Gross is telling us that bonds--at least Treasury bonds--do not provide enough reward to cover the potential downside risk. And, I agree with that (especially if you are a buy-and-hold investor).

"However, starting in April and May I started pulling out of equities and moving into bonds (mostly short- and intermediate-term government and commercial securities)--not because bonds are such a good investment but because U.S. and European equities were starting look like they may be worse investments. And, simply putting it into a money market account is equivalent to putting it under a mattress.

"So, I'll take a 3% return knowing that it barely covers inflation over risking a loss on equities and I will be looking to change course as soon as Federal Reserve chairman Ben Bernanke decides to raise rates or equities look like they have a better future ahead of them."

Poster Burchard is on the same wavelength, opining, "As a 63-year-old retiree, I've always kept my asset allocation at 70% equity/30% bond, which is contrary to traditional theory, but it has enabled me to recoup my portfolio value back to what it was in March 2008. However, I shortly see storm/tornado clouds on the U.S. and Europe's horizons, so I'm selling all my "risky/semi-risky" equities and buying/holding only bond exchange-traded funds with a duration of less than three years to get my AA to about 50-50. I don't trust munis, either. Maybe I'm the current Chicken Little, but I sleep better at night."

Have Morningstar users heeded Gross' advice, spurred on by incredible shrinking fixed-income yields and the specter of rising interest rates? That's the question I posed in the Income and Dividend Investing section of Morningstar.com's Discuss Forum.

User responses were all over the map, prompting statsguy to write, "I don't know what type of an article you could write that summarizes this cacophony of posts. Good luck." (Thanks for the vote of confidence, statsguy!)

But the posts, though varied, revealed valuable insights about the relative attractiveness of stocks, bonds, and cash. They also showcased a range of opinions about asset allocation, with many users commenting that they stick with their well-laid plan regardless of what the talking heads--or even full-blown gurus like Gross--are saying. Click here to read the complete thread.

Taking on a Little More Risk Seems Worthwhile
Several posters agreed with Gross that stocks' prospects look brighter than bonds' right now, even as they acknowledge that equity valuations are less attractive than they once were.

Poster Kevindow, for example, after noting that investors shouldn't let their asset allocations get buffeted around by the news flow, wrote, "If you look at a scalable chart of  Vanguard Total Bond Market Index ,  iShares MSCI EAFE Index , and  iShares S&P 500 Index, , you realize that the bond market has significantly outperformed the foreign equity markets (EFA) and the S&P 500 (IVV) during the past three- and five-year periods. If you believe in reversion to the mean, which is indeed time-tested, then fixed income is likely due for a correction during the next few years.

"So forget about trailing returns, which would lead you to favor fixed income over equities, and realize that interest rates have no place to go but up and that equities, both domestic and foreign, are the place to invest in the next few years."

Poster DuaneJ agreed with that overall viewpoint: "I have the highest allocation to stocks, both in dollars and in percentage of assets, that I've ever had. I think anyone with a time horizon of 10-plus years should be as heavy into stocks as they can tolerate today. We'll be lucky to match inflation with bonds during the next decade, in my opinion."

FidlStix was also planning to maintain a robust equity weighting into retirement, noting, " I expect to hold a 60% equity/40% bond asset allocation into retirement. I know that is considered too risky by many analysts, but as someone who arrived late at the investing party as dessert was being served, taking on a little more risk seems worthwhile."

What a Bizarre Idea
For other investors who posted in the forum, current equity valuations make them inclined to subtract from equities, not add.

Rlovendale wrote, "I've actually decreased my equity exposure recently after the markets have gone up 30%-plus since I started investing last January. I have about 65%-70% equity (a little more than 50% international), 20% bonds (mostly corporate; some mortgage), and 10% cash (held by managers searching for value). Even though I'm only 25, I'd still like to have something to rebalance with should we have another dive. Since I'm starting graduate school this fall and won't have income to contribute to my Roth IRA, I also won't be able to take advantage of dollar-cost-averaging benefits. This was another factor in my decision to be a little more conservative."

BuyerBeWare, while still maintaining a fairly stock-heavy allocation, has also been peeling back. "After the downturn, I did the opposite of what the herd was doing. I bought at a discount by shifting 100% of my investments into equities. I continued to invest 100% in equities. That enabled me to recoup my cost basis and some of the gains lost. Recently, because the market has been on a tear for two years, I established a 17% position in bonds and 5% in cash using the gains I recouped."

Darwinian, never one to beat around the bush, wrote, "Shift into equities now? At a time when the market has been rising for two years? After equities have doubled in price? What a bizarre idea.

"I have had to toil continuously to sell off enough equities, during the past two years, to keep them from taking over my whole portfolio. During this time, I have reallocated from 75% equities (a temporary concession to momentum in the summer of 2009) back to a long-term allocation of 65%. I reached this point early this year and have been holding steady since. May was the first month this year that I did not sell equities. I don't plan on buying anything back until it has dropped at least 25%."