It is said that the best relationships pair two kinds of people: black cats and golden retrievers.
The ‘black cats’ are guarded and independent. They don’t open up much at first and can seem cold or moody. The ‘golden retrievers’, meanwhile, are warm, friendly and upbeat. One brings pragmatism while the other brings excitement. They are the yin to each other’s yang.
The same could be said of bond and equity investors.
For much of my career, bond investors have been the black cats of the market – constantly worrying about what could go wrong and complaining about their lot in life. It has, after all, been a hard two decades to invest in fixed income.
Paltry yields were a tough starting point, with investors required to take on high yield or emerging market risk to make any sort of meaningful return. The once-reliable asset class had broken down to the point of being almost useless for investors, who were forced to hunt elsewhere for income – often in equities.
Equity investors, by contrast, are paid to be optimistic. They have to assume stocks will do well, growth can continue, share prices can rebound and that the good times can keep rolling. Since the financial crisis of 2008, stocks have marched largely higher, which has only helped to perpetuate this outlook.
In hindsight, every dip has been a buying opportunity, whether it was the Covid pandemic, the interest rate-driven sell-off in 2022 or the market tantrum following US president Donald Trump’s Liberation Day last year. Every crisis has been relatively short-lived, making it a phenomenal time to be an equity investor.
However, in recent months I have noticed things are changing. Suddenly, the usually pessimistic bond investors are grinning like Cheshire cats, while equity investors are a little less enthusiastic about the world than they once were.
So why is this? On the bond side, for the first time in decades they are now working from a starting income that makes the asset class extremely attractive. The long-run average return from equities is often cited as around 6%. Yet today, government bonds are paying around 5.5% – just shy of equity-like returns. Take a bit of risk by going into credit markets and fixed income investors can easily get an income that matches that long-run average.
Meanwhile, equity investors are dealing with the opposite problem. The rise of AI has been a game changer for markets, but there is so much we still do not know about its potential uses and how the nascent technology will work in the future. This makes forecasting potential profits from AI extremely difficult and leaves companies on wildly different valuations depending on which manager you speak to.
What is undeniable is that the AI winners have risen substantially in recent years, which is wonderful for those investors who have made large profits but raises questions of how long the good times can last. After all, nothing lasts forever and what goes up must eventually come down.
No one is saying that we are heading for an imminent recession or that there is a stock market collapse around the corner. But it is clear the world is changing. Investors had to own equities for most of the past 20 years to make any sort of return. That is no longer the case.
So right now bond managers are the cats who have got the cream, while equity managers are akin to dogs whining that something might be out of the ordinary.
It seems to me now is the time to start thinking about shifting some of the equity allocation to something a little safer, before the dogs start really barking. Because once they do, it might be too late.
Jonathan Jones is editor of Trustnet. The views expressed above should not be taken as investment advice.