Executive Summary

It’s not all in the (market) timing

It’s long been a truism that timing the market is notoriously difficult. Indeed, we believe the evidence is fully conclusive against investors who try to move in and out of the market over relatively short time periods (say month to month). Unfortunately, this fact doesn’t seem to stop most investors from trying. The fear of losing money is a powerful motivator and is the reason why many investors tend to sell out very late into a market selloff. Similarly, many investors tend to buy into rallies late, fearing they are missing out. Likewise, many investors chase performance from year to year, when even a well articulated strategy doesn’t appear to be working as well as hoped.

This is not to suggest that there is no utility in assessing relative valuations and risks within the capital markets. In fact, doing so is the foundation of our investment processes. A longer-term view and a healthy dose of fundamental analysis are essential ingredients for investing successfully over the long term. Clearly, valuations among different asset classes are not equally compelling at all times.

There is a vast field of study called behavioral finance, which attempts to understand, and even predict investor behavior. Interestingly, the study of behavioral finance has given institutional investors the ability to invest “opportunistically” around the tendency of retail investors to misallocate capital from these timing errors. Many institutional investors (ourselves included) consider how retail investors are allocating their capital — not with the intent of following suit, but rather as additional support for taking an opposite viewpoint.

Diverging investment trends in equities and bonds

We must point out that today there exists one of the most obvious and significant disparities in relative valuations. And, it is likely many investors are being whipsawed yet again. The chart below shows the cumulative net investment in, or redemptions of, both equity (stock) mutual funds and bond funds. The vast majority of these are owned by retail investors, so this is a good proxy for how investors are currently allocating their capital. You can see that investors have generally been selling stocks for the past three years. Far more obvious is investors’ appetite for bonds over the same period.

Source: Bloomberg

How market rallies and selloffs compare with investment activity

Now let’s look at how those markets have performed over the same time period. Here we are using the S&P 500 and Barclays Aggregate Bond as proxies for the stock market and the bond market. If you compare the two charts closely, you’ll see that the time periods in which investors were buying stocks is typically after the market has already rallied. Likewise, they tended to sell after the market had fallen. Meanwhile, they’ve been buying bonds at ever-higher prices (and lower yields).

Source: Bloomberg

Let’s make it a bit more interesting by considering relative valuations. Using the same proxies, we can now compare the earnings yield (earnings/price) for the S&P 500 against the gross yields offered by the Baa rated bonds within the Barclays Aggregate. For perspective, it is rare for the earnings yield on stocks to eclipse the gross yields of bonds. We’ve included the yield on 10-year Treasuries to illustrate the even greater disparity in valuation of government bonds, which we view as being in a bubble.

Source: Bloomberg

Based on this measure, investors are clearly overpaying for bonds in an already abnormally low-yielding environment. At the same time, they are unwilling to buy stocks when they are less expensive than they’ve been in decades, based on most valuation measures.

Investing in the current economy

Can stock prices fall from here? Certainly. But so can bond prices, which will fall when interest rates begin to rise. With corporate profits and profit margins at record levels and economic data improving (even if marginally), we think there’s an opportunity, and have been positioning client portfolios accordingly.

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Mark A. Griffin, CIMA®
Principal, Chief Investment Officer
mark.griffin@cliftonlarsonallen.com 
920-232-2238

CliftonLarsonAllen Wealth Advisors, LLC
The purpose of this publication is purely educational and informational. It is not intended to promote any product or service and should not be relied on for accounting, legal, tax, or investment advice. The views expressed are those of CliftonLarsonAllen Wealth Advisors, LLC (“CLA Wealth Advisors”). They are subject to change at any time. Past performance does not imply or guarantee future results. Investing entails risks, including possible loss of principal. Diversification cannot assure a profit or guarantee against a loss. Investing involves other forms of risk that are not described here. For that reason, you should contact an investment professional before acting on any information in this publication.

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