In 2013, fixed income sold off after Chairman Ben Bernanke signaled an end to the Fed’s bond purchasing program. This led to just the third negative calendar year return for bonds since 1970! Since this “taper-tantrum,” investors have been calling for a tidal wave of fixed income assets to reallocate into stocks.  The Fed has raised interest rates three times over the past fifteen months and has become more hawkish with its language, but investors continued to allocate funds to fixed income. With volatility in the equity markets calm, coupled with strong economic data, the Fed’s plan of three rate hikes in 2017 is well underway. Will this be the tipping point for investors to rotate out of bonds and into stocks?

According to Fidelity, from 2009 through October 31, 2016, domestic and international equity mutual funds and ETFs combined saw $600 billion of net inflows, while $1.4 trillion of net assets poured into bond funds and ETFs. Over the same time, the S&P 500 (SPY) produced a cumulative total return of 187.6% and the Barclays Aggregate Bond Index (AGG) returned 35.1%. Stocks massively outperformed bonds, yet investors allocated almost two-and-a-half times the number of assets to bonds over stocks! Can this bull market continue to run higher?

Bonds have been a major laggard since the election, with the AGG down 3.5%, and the SPY up 14.5%. Yet, according to the Investment Company Institute, $78 billion in net flows have gone into bond funds and ETFs, compared to the $90.7 billion net funds that have gone into equities, since the election.The “Great Rotation” is well underway, but it’s from global investors continuing to put cash to work, rather than making a major shift in asset allocation. Could a reallocation out of bonds into stocks be next?    

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A stock’s price is what you pay, but a stock’s value is what you get. The S&P 500 is up 23.6% over the past twelve months. However, when looking at valuation, the market is not overpriced, though certainly not cheap. The market is trading at 18 times 2017 price-to- earnings (P/E) multiple; an 11% premium to its 25-year average P/E of 15.8. Comparatively, this is nowhere near the dotcom bubble apex, nor during the doldrums of the 2008/09 financial crisis.  Compared to bonds and cash, equities are very attractive. With the yield on the US 10 year bond having risen from 1.47% pre-election, to 2.5%, with rising interest rates putting pressure on bond prices, stocks should outperform bonds on a total return basis, more than 2.5% per year, over the next ten years. With the US economy continuing to improve, and if President Trump and the Republicans are successful at passing corporate tax reform, stocks should continue to move higher as the “E” in the P/E is likely understated.

Where do you go from here? First, remain diversified and disciplined to rebalancing your portfolio. Second, stick to a total return strategy. Don’t shun stocks because the dividend yield might be low, or chase a high yielder, but rather look at how the management team has historically returned cash to shareholders. Finally, keep focused on the long term. Since 1980, despite often large sell offs during a year, the market finished up in 28 of those 37 years!

Note: John J. Petrides, MBA, is a Managing Director and Portfolio Manager at Point View Wealth Management, Inc., a registered investment advisor at 382 Springfield Ave., Summit.

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