Managers’ Choice of Stocks vs. Bonds Hits 14-Year Low

U.S. investment managers have a greater percentage of assets invested in bonds instead of stocks than at any time since the global financial crisis. But that allocation decision may not mean exactly what it once did.

Bank of America Securities’ latest monthly fund manager survey showed that asset managers have a net underweight of 29% in stocks compared with bonds. That’s the biggest disparity in the survey since March 2009. Fund managers now have a net 10% overweight in bonds.

Fear of a credit crunch spreading throughout global financial markets in the wake of last month’s banking system turmoil exacerbated the ongoing allocation shift that began when the Federal Reserve started raising interest rates early last year.

No Longer Just a Safe Haven

For most of the past two decades, fund managers have sought bonds mostly as a haven when uncertainty grips equity markets and to provide a ballast to their portfolios.

That hasn’t changed. However, rising interest rates also have boosted bond yields. Along with expectations the Fed may soon stop raising or even start reducing interest rates, potential returns from fixed-income securities appear more appealing than perhaps any time since the financial crisis.

The yield on the 10-year U.S. Treasury Note topped 4% late last year for the first time since October 2008. Issuers of investment-grade corporate bonds, mortgage-backed securities, high-yield debt and an array of other fixed-income securities use 10-year note as guide for setting their yields.

Meanwhile, the earnings yield on stocks has declined during the Fed’s rate hike campaign. The aggregate yield on S&P 500 stocks currently equals 4.50%.

That means the broad U.S. stock market market now yields less than a 3-month U.S. Treasury bill, currently yielding more than 5%.

Bonds, of course, typically offer less risk and volatility than stocks, partly because they provide guaranteed income that stocks don’t.

So when bonds yield roughly the same as stocks, they’re attractiveness for potential returns increases, particularly on a risk-adjusted basis. In addition to their haven characteristics, that likely explains part of the allocation shift expressed in this month’s BofA survey.

Current Expectations

Nonetheless, this month’s survey showed that concern about economic growth continue steering fund managers away from stocks. About 63% of those surveyed expect weaker global growth in the next 12 months, ending four straight months of improvement in that metric.

At the same time, 84% say consumer inflation will decline. With weaker growth and lower inflation expected, 72% say short-term interest rates will decline—the most since November 2008—with 87% predicting the Fed will begin cutting rates within the next 12 months.

Meanwhile, despite political wrangling regarding the U.S. debt ceiling, 80% of fund managers remain confident the federal government will raise its debt limit by September.

Biggest Risks

Forty percent of managers said their portfolios reflect lower-than-normal risk levels. However, the potential for a bank credit crunch and global recession is the biggest concern for 35% of the fund managers. Among other risks, 34% said high inflation that keeps central banks from reducing rates, 16% cited a “systemic” credit event and 11% cited worsening geopolitics.

Regarding credit concern, 48% viewed commercial real estate in the U.S. or European Union as the most likely culprit, with U.S. “shadow” banking ranking second at 25%. Only 4% foresee a potential downgrade of U.S. Treasury debt, tied to debt-ceiling deadlines, as the mostly likely source.