Successful Investment Isn't a Popularity Contest

This blog post originally appeared on RealMoney Silver on March 1 at 7:56 a.m. EST.

The most popular investment places often yield the most disappointing returns. In recent years, three examples come to mind -- money market funds, U.S. fixed income and emerging market equities. In the 2008-09 bull market in risk aversion -- leading into and coincident with the stock market crash -- money market funds rose to a record $4 trillion. Stocks proceeded to double from March 2009 to the present as a preference for cash was exactly the wrong strategy. Following 10 years of material outperformance of fixed income over equities, record inflows into bonds accumulated during 2009-10 as investors sought safety and yield following the Great Recession. Once again, the asset of choice -- bonds -- fared poorly even as inflows accumulated. Bond yields rose and bond prices fell, despite the Federal Reserve announcement and implementation of QE2. During 2009-10, when the investment outlook began to clear, all of the incremental retail inflows were committed into nondeveloping foreign markets. But beginning in early 2010, emerging markets began to underperform the U.S. stock market. And by November 2010, that underperformance grew more conspicuous as the most popular strategy again let investors down. Over the past few months, retail inflows have begun to move into U.S. stocks (and have redeemed out of money market funds and municipal bonds) as investors have arguably been emboldened by the great performance of U.S. stocks. Indeed in January 2011, more than $11 billion flowed into domestic equity funds. January's investment in domestic stock funds represented the largest amount of retail inflows since mid-2009 and likely explains the consistency of the market's advance in 2011 (and the absence of any meaningful correction even in the face of some adverse geopolitical developments that have contributed to a large hike in energy prices). Bulls argue -- and there is merit to the view -- that though stocks have doubled, it is early in the increased retail appetite and popularity for U.S. stocks. In support, they observe that in the four-year period ended December 2010, retail investors liquidated more than $300 billion in domestic stock funds while purchasing $750 billion of bonds, bringing retail exposure to equities to relatively low historical levels. I have argued and continue to argue that the investment shock of 2008-09 runs deep and will serve to limit retail inflows. Moreover, unlike almost any other time in history, the non-upper-income investor class may not be positioned economically to invest in equities to the degree the bulls expect. That investor class faces unique economic challenges and conditions and lower confidence in the form of an unprecedented drop in home prices (which has damaged the consumer's balance sheet), still high (though improving) debt ratios, the insecurity brought on by structural unemployment (and an elevated jobless rate) and the screwflation of the middle class (as the cost of the necessities of life have risen during a period in which wages have stagnated, serving to depress disposable incomes). In summary, the recent increased commitment to domestic stock funds may disappoint and may not prove durable, and -- as was the case of money market funds, emerging market equities and fixed income -- the renewed popularity of domestic equities may not pay off in the fullness of time. Caveat emptor. Add Comment Tweet At the time of publication, Kass and/or his funds were long/short XXX, although holdings can change at any time. Doug Kass is the president of Seabreeze Partners Management Inc. 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