The Opportunity Cost Keeps Growing and Growing

In a recent report we demonstrated that, contrary to popular belief, investors are not faced with a low return environment. Through October 31st, the annualized five-year return on the S&P 500® exceeded 13%. We asked how long will returns need to exceed expectations before investors will admit that the financial markets are not in a low return environment? (See,

It appears that a fear of equities and the resulting poor asset allocations have resulted in below normal returns. Investors as a group seem to be rationalizing their poor returns by agreeing with each other that it is difficult to achieve higher returns. The reality, however, is that equities are providing higher returns, and the opportunity cost of under-weighting equities is growing.

It’s fear. It’s not demographics

Many observers have claimed that investors’ search for more conservative investments is attributable to demographics. It is common to hear that the baby-boomers are aging and have a greater need for income-producing investments.

We have disagreed with this theory. Of course it is true that the baby-boomers are aging, but their preference for fixed-income and income-oriented equity seems to be more a function of fear than of demographics. They feel that investing for income is safe, but investing for capital appreciation is risky. 2008’s stock market debacle remains fresh in their memories, and income-producing strategies outperformed during that time because of the low betas imbedded in dividend strategies, and because of the negative correlation that existed between treasuries and stocks.

Safe strategies are safe until everyone thinks they are safe and makes those strategies the core of their portfolios. The over popularity of any strategy is ultimately its demise because valuations get stretched and the underlying macroeconomic environment typically changes. Investors can be left with overvalued investments that may be inappropriate for a subsequent economic setting.

That appears to be the case today with many fixed-income investments. “Lower for longer” was this past summer’s popular investment theme, but the popularity of that theme coincided with the trough in inflation expectations.