I touched on this question, in a Comment at the bottom of a recent post; however, I believe that the basic topic needs some clarification. Just before the U. K. voted to “Leave” the European Union, the Prime Minister (at the time) and many British economists had cautioned that the long-term economic impact of leaving could be quite substantial. Soon after that vote, some Britons began to doubt their decision, and a reported two million marched in London—asking to vote again.
Although the main stock index on the London Stock Exchange, the FTSE, dropped for the first two days after the Brexit vote, it then began to surge. It is now up by 12.8% since then. Most major global stock indices have likewise strengthened, and all three major U. S. stock indices have reached all-time highs. But, where’s this strength coming from?
Last Thursday, the Bank of England and the Exchequer, the British central bank and treasury, respectively, announced a multi-pronged package of Monetary and Fiscal Policy actions, of substantial proportions. This is the government’s attempt to confront the negative economic impact, which they expect the Brexit to cause. At the same time, central banks around the world have maintained their base lending rates near, and some even below, zero. Longer-term bond yields in most countries also remain near all-time lows.
Bond yields are an indicator of the strength of an economy. When consumers fear a loss of their jobs, and business revenue is depressed, reduced bank loan demand follows. That causes deposit rates to drop, and savers to suffer. Additionally, the depressed commodity prices will also hurt the countries that depend on those revenues as a vital source of income. And, at the same time, Corporate Earnings remain flat in the U. S, particularly due to weak export demand.
It is usually advantageous for investors to establish balance in their portfolios, by spreading their investments among the “Asset Classes”—stocks, bonds and cash. That strategy reduces the overall portfolio volatility, as stock and bond prices normally move counter to one another. And cash obviously is intended to provide sufficient liquidity to meet unexpected financial needs. But, with the stock and bonds markets currently both quote strong, undisciplined investors are straying from that proven strategy. And this leads me to consider a potential answer to my initial question.
When investors shy away from current bond yields, they feel very little compulsion to tie their money up for years at those low rates. (Sure, you can sell marketable bonds, if you need, or want, to take some money out; however, the price might be quite a bit lower than what you paid for them.) Accordingly, many investors might be enticed, by the rally in the stock markets, to binge on them.
Now, I’m not suggesting that the markets are gearing-up for a sharp fall-off anytime soon; however, I am pointing-out, that the recent stock market rally—after several corrections earlier this year—might come to an end, at some unforeseen time. If you might be over-extended in stocks, be especially sure to check your portfolio frequently. (I will offer some suggestions as to what to look for in a subsequent post.) For now, just keep in mind that: What goes up can come down, and vice versa.