Posted by on Jun 17, 2013 in Blog, Columns, Featured |

By Jason Zweig | June 14, 2013  5:37 p.m. ET
Image Credit: Christophe Vorlet

If you are an investor and aren’t on the verge of retirement, your fondest wish should be for another whiff of fear that will tip even more assets into the bargain bin.

On May 22, Federal Reserve Chairman Ben Bernanke hinted that the Fed could reduce, or “taper,” the bond-buying program that has nudged markets to record highs.

 The ensuing global selloff in stocks and bonds has left some assets (like high-yield bonds) still expensive, some (inflation-protected bonds) mildly attractive and some (international stocks) looking like a steal.

“We’re all so encouraged by the 24/7 news cycle to focus on the short term, it’s too easy to panic when what we thought was attractive gets 10% cheaper,” says Rob Arnott, chairman of Research Affiliates, an investment firm in Newport Beach, Calif., that advises on $150 billion in assets.

Investors should welcome the falling prices that make assets cheaper. Instead, the markets resemble an immense school of fish, shifting from feeding frenzy to reversal in a single silvery flash. Lately, with so many people trading under the influence of cheap money, the customary buy-high/sell-low behavior of the crowd has bordered on the absurd.

In the 20 weeks between Jan. 1 and May 22, nearly $3.4 billion of new money gushed into funds specializing in high-yield bonds, even as the yields on those bonds hit record lows (and as their prices thus went to record highs).

Then the “tapering” fears struck. Between May 23 and this past Wednesday, a mere 15 trading days, people yanked out $7.8 billion—including nearly $1.5 billion on June 7, the largest one-day outflow ever, according to EPFR Global, an investment-research firm.

“Investors who wouldn’t normally have been in high yield at all went into it [in recent months] because yields were so abysmally low everywhere else,” says Martin Fridson, a veteran high-yield analyst and chief executive of FridsonVision, a research firm based in New York. “It seems they all were thinking, ‘As long as I’m the first one out, it’ll be OK.’ But not everybody can get out first.” High-yield bonds are “certainly not a bargain yet,” warns Mr. Fridson, who estimates that yields have to rise another 0.5% to hit fair value.

The same behavior has flooded through funds that invest in emerging-market stocks ($16.2 billion in over 20 weeks, $7.8 billion out in 15 days), emerging-market debt ($3.8 billion in, $999 million out) and Japanese stocks ($13.6 billion in, $437 million out), among other categories.

“As I visit clients world-wide, almost every single investor tells me the same thing,” says Brian Singer, who runs the $145 million William Blair Macro Allocation Fund, which invests in a variety of assets around the world. “The only place they’re seeing any opportunity is in the U.S.”

He adds, “If it’s the global consensus, you can be pretty sure it’s priced in”—meaning that the wise investor should shop beyond U.S. stocks.

Mr. Singer thinks stocks in Europe and in emerging markets have gotten much more attractive in the recent selloff. He projects future returns of up to 14.5% annually over the next eight years on European stocks (and at least 20% in the Italian and Spanish markets) and 11% on emerging markets.

U.S. stocks are at a price/book ratio—or market value relative to corporate net worth—of 2.3, or more than 10% higher than they were at year-end, calculates Ryan Larson, a vice president at Research Affiliates. The same ratio on emerging-market stocks has fallen below 1.5, from 1.6, making them more than one-third cheaper than U.S. stocks.

Over the same period, the dividend yield in the U.S. has dropped to less than 2.1% from 2.2%, even as the yield on emerging markets has risen to 2.9% from 2.7%.

European stocks trade at discounts nearly as great, with dividends averaging 3.5%; Japan is even cheaper, although dividends there are lower at 1.7%. While the prospects for growth in Europe and Japan are dim, expectations are even dimmer, raising the potential for positive surprises and higher future returns.

Treasury inflation-protected securities, or TIPS, “had been wildly uninteresting for a year-and-a-half,” says Mr. Arnott of Research Affiliates. But they have dropped so fast in the past few weeks—especially those with the longest-term maturities—that “they’re becoming interesting again.”

Right on cue, investors have pulled $1.5 billion from TIPS funds in the past 15 days, according to EPFR Global.

Gemma Wright-Casparius, manager of the $35.2 billion Vanguard Inflation-Protected Securities Fund, points out that long-term TIPS are now “fairly attractive” if inflation runs higher than 2.05% over the next decade or more. Considering that the cost of living rose 2.7% annually over the past 10 years, that probably is another bet worth taking.


Source: The Wall Street Journal