Bonds and gold have outperformed stocks. That can't last. And even if stock returns are subpar, they're the cleanest dirty shirt.
The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, Abbott Laboratories and AbbVie, La Monica does not own positions in any individual stocks.
Even though the S&P 500 is not too far from its all-time high, it's been a reluctant rally. Investors are still nervous.
How do I know this? Well, the CNNMoney Fear & Greed Index continues to show signs of Fear even though the so-called "fear gauge" of the market, the VIX (VIX) is near a 52-week low. (Our index includes the VIX and six other indicators of market sentiment.)
Click chart for detailed look at the Fear & Greed index.
And just look at the kind of financial assets that have done well this year. Fearful investors have bragging rights so far in 2014.
Gold has outperformed the broader market.
Utilities have outperformed the broader market.
Long-term Treasury yields have plunged.
This isn't sustainable. The only reason for gold, utilities and bonds to be better performers than the S&P 500 for a long stretch is if the economy is imploding. As in 2008. Or 1929. That's not happening.
Paging Men Without Hats! Investors are doing the Safety Dance! (We can leave your friends behind.)
Yes, stock returns are likely to be subpar for the next few years ... especially if you've grown accustomed to the insane gains we've had since the market bottomed in 2009. But so what?
Small returns for stocks are better than the zilch you'd earn from cash or in bonds after inflation. And gold? That may be a good hedge, but it should be only a small part of your portfolio, not your entire nest egg.
Most experts I spoke to say that stocks continue to be the best game in town. That isn't the same thing as saying that stocks are going to go up to the ionosphere like they did last year. But it's all relative.
Hank Smith, chief investment officer of Haverford Trust, uses a Margaret Thatcher-coined acronym to rationalize why investors should buy stocks over bonds or gold. TINA. There Is No Alternative.
I agree. To paraphrase Pimco's bond guru Bill Gross -- by way of Johnny Cash -- stocks are the cleanest dirty shirt.
So what should investors be doing now? Pulling money out of U.S. stock funds is probably not the wisest idea. It's a panic move.
Smith says investors need to stick with big blue chips. These companies can give you the potential for gains through earnings growth as well as income from sizable dividends. And you can build a diversified portfolio with this group as opposed to making a bet on just one sector.
Some examples of stocks Smith's firm owns are healthcare giants Johnson & Johnson (JNJ) and Merck (MRK); tech leaders Microsoft (MSFT), Intel (INTC) and Cisco (CSCO); brand name stalwarts Coke (KO) and Pepsi (PEP); big banks Wells Fargo (WFC) and JPMorgan Chase(JPM); and energy titans Chevron (CVX) and ConocoPhillips (COP).
Ted Parrish, co-manager of the Henssler Equity fund, agrees that this is the time to flock to safe quality bets. And that doesn't have to mean boring utilities.
"We don't have a permanent pair of rose-colored glasses on, but this rotation into defensive assets is unsustainable," Parrish said. His fund also owns Wells Fargo. Other dividend-paying companies he likes are regional bank BB&T (BBT), Canadian financial firm Bank of Nova Scotia(BNS) and tech companies Applied Materials (AMAT), Qualcomm (QCOM) and Oracle (ORCL).
Parrish also thinks the bull run in bonds may soon come to an end. Remember how everyone thought that rates would rise earlier this year because the Federal Reserve was shifting away from quantitative easing? Well, the Fed hasn't deviated from that plan. But someone hasn't told the bond market apparently.
"It's weird to see bond yields go down when you know the Fed has to increase rates eventually. That day of reckoning is coming, and that's going to hurt bond prices and push yields higher," Parrish said.
It makes sense. Investors have flocked to the types of things that do well if you want to go hide in a bunker and wait for economic Armageddon.
But the last few jobs reports are hinting at slow and steady (if not spectacular) growth in the economy. Sure, I've been lamenting for years about how the recovery is low and slow. My belovedbarbecue recovery metaphor. But at least it is a recovery.
That spells trouble ahead for bonds and utilities, which are basically bond proxies thanks to their large dividend yields.
"In an improving economy, rates should normalize and bonds and utilities will underperform again," says Bernie Williams, chief investment officer of USAA Investment Solutions ... and not the former New York Yankee outfielder.
Once again, this does NOT mean that stocks are going to have a smooth ride up. The bumpy ride we've had this year will likely continue. And don't get greedy and expect another year like last year. Those are the exceptions. Not the rule.
"I've been telling clients all year we are not getting 30%+ returns again, but I don't expect the S&P 500 to fall apart either. There is just going to be some gut-wrenching volatility," said John Norris, head of wealth management at Oakworth Capital Bank.
Norris adds that as long as investors can withstand the occasional turmoil and accept the fact that normal returns are in the single digits, then there's absolutely no reason to bail on stocks for the perceived safety of fixed income.
"Nobody likes losing money. But at the same time, even my most risk averse investors don't plan on dying in the next three months," Norris said. "If you have a 20-year window, stocks are not going to underperform bonds."
