Tags: bonds | investors | pimco | el-erian

Small Investor Fears Could Trigger New Plunge

Monday, 23 Aug 2010 12:31 PM

In what could turn out to be a self-fulfilling prophecy, small investors are heading away from a perceived risk in stocks and piling into bonds — dramatically increasing the risk of a future bond plunge should the tables turn.

Individuals took $33.12 billion out of domestic mutual funds in the first seven months of 2010, according to figures from the mutual fund trade group the Investment Company Institute (ICI).

Meanwhile, they put more money to work in bond funds, which pulled in more money than stock funds for 30 months straight through June, according to ICI numbers reported by Bloomberg News.

The group said that $559 billion went into bond funds in that 30-month period, compared to $209.4 billion leaving domestic stock funds and $24.4 billion departing from foreign stock funds.

As the recession veers toward a double-dip — revised second-quarter GDP figures are due out Friday — investors are in no mood to follow stocks back down. Many were burned in the dot-com collapse and, later, the 2008 credit debacle.

Meanwhile, the values of homes, where most people traditionally feel they have built up a reliable nest egg, are stuck in doldrums that could take decades to end.

Many investors might not have much choice. As the Baby Boomer retirement wave cranks up and unemployment sticks to close to 10 percent, some individual investors are taking matters into their own hands.

For instance, Fidelity Investments recently reported a jump in so-called “hardship” withdrawals. The number seeking to cash out a portion of their 401(k) funds earlier hit 62,000 in the second quarter, up from 45,000 a year ago.

Of those, nearly half (45 percent) had taken out a hardship withdrawal the previous year, reports the Associated Press.

The problem with bond funds, of course, is a sudden reversal of sentiment. If you buy bonds directly, no problem: Your rate, however low, is locked in until maturity in a non-callable bond. Even a callable bond returns your principal.

A bond fund, however, is just a big pot of money — yours and that of millions of others. If your fellow investors decide to bolt for a recovering stock market, the fund must sell holdings to pay cash to those departing investors.

And sell they must, even at a loss. It’s a lot like the flight that forced so many money market funds to flirt with breaking the buck during the 2008-2009 stock crisis.
A lot depends, of course, on taking a relatively short-term bet: Will the U.S. face deflation, or not?
The gurus at Pimco, the world’s biggest bond fund, talk of a 25 percent to 35 percent risk of deflation setting in.

"The U.S. is still able to avoid deflation. We do not think that deflation and double-dip is the baseline scenario, but we think it's a risk scenario," Pacific Investment Management Co. (Pimco) Chief Executive and co-Chief Investment Officer Mohamed El-Erian told reporters on Aug. 5.

El-Erian took the point farther with a later comment, asking if you would go for a ride in a car today if there were a 25 percent chance of getting into a car accident.

If deflation happens, the bond rally could really heat up as investors flee stocks even faster. Yet the other possibility is runaway inflation, thanks to the massive quantitative easing under way to stave off that very deflation.

Fed Chief Ben Bernanke is taking a cautious middle road, saying recently that the Fed would buy $18 billion worth of Treasuries through mid-September using maturing mortgage securities it already holds. Traders also believe the Fed will keep rates at virtually zero for another 12 months, a sign that deflation risk remains quite real.

Yet companies are sitting on huge piles of cash and the recovery, however tenuous, is not dead yet. If a spate of good news tips investors back into stocks, the result could be a rapid bond fund collapse.

Yet the bond rally might have more room to run. If it’s a true bubble, that last leg would be vertiginously upward.

And, if it’s anything like the bubbles of the recent past, our hindsight will be 20-20.


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In what could turn out to be a self-fulfilling prophecy, small investors are heading away from a perceived risk in stocks and piling into bonds dramatically increasing the risk of a future bond plunge should the tables turn. Individuals took $33.12 billion out of...
bonds,investors,pimco,el-erian
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2010-31-23
Monday, 23 Aug 2010 12:31 PM
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