One of the casualties of zero-interest rate policy has been the important balance in investing between risk and reward. After three rounds of quantitative easing and seven years of 0% interest rates, investors have been told in no uncertain terms: the streets are paved with reward; forget about risk.
With U.S. equities hovering near all-time highs, having more than tripled since March 2009, this is the primary message we are hearing from investment advisors today. There is no risk in the new investing paradigm so don’t bother worrying about it. The S&P 500, we are told, is the new 6-month CD.
And while on the surface it seems that this is true and nothing has changed, when we look underneath it is clear that something very different is going on.
More Risk, Less Reward
Over the past year, within many areas of the investable landscape, taking more risk has actually led to less reward.
In the credit markets, High Yield bonds and Senior Loans are flat since the beginning of 2014 while long-term U.S. Treasuries are up over 25%.
Last week, High Yield credit spreads hit their widest levels in over two years.
Distressed bonds are also reflecting a changing risk appetite, declining over 45% since last June.
Within the equity market, High Beta stocks (SPHB) have declined 3% over the past year while Low Volatility (SPLV) names have advanced close to 14%. The ratio of High Beta to Low Volatility is at its lowest level since 2013.
Within the currency market, Emerging Markets are trading at multi-year lows as investors are increasingly seeking out the safety of the U.S. dollar.
When Risk Matters Again
Whether investors realize it or not, risk is starting to matter again. The Dow may be flat over the past eight months but that doesn’t mean holding a higher percentage of stocks than your risk tolerance warranted was a good decision. Just because an investment is not down does not mean it is without risk.
At Pension Partners, evaluating the balance between risk and reward is at the heart of our investment process. Currently, risk is outweighing reward with leadership in Utilities (click here for our research on Utilities) and long-duration Treasuries (click here for our research on Treasuries) suggesting an increase in volatility may be coming. As such, we have been defensively positioned since early July and will remain so as long as the risk/reward dynamic remains unfavorable.
Many U.S. equity investors believe we are sailing in calm waters here and nothing but smooth sailing lies ahead. With the Volatility Index (VIX) at 13 and years since we’ve seen a decline last more than a week, this feeling is understandable. But make no mistake about it, there’s a storm brewing just beyond the mountains. We don’t know if that storm is going to lead to another small decline as we have seen a number of times over the past few years or something larger. If nothing else, though, this storm will serve as a healthy reminder that sailing in equities is not without risk.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
CHARLIE BILELLO, CMT
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of three award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors previously held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
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