Join Together With The Band

There is an old saying which says that if you can't beat them, join them. That is exactly what is happening in some areas of the capital markets. One area is the equity market where share prices have been pushed higher by mutual funds being forced to take money of the sidelines as investor dollars continue to flow into funds. The same can be said of the high yield fixed income market. Flows into high yield funds have risen during the past month. Have investors jumped in too soon?

Maybe, maybe not. Although equity prices are rallying on not much more than hope (hope that the economy has bottomed and the economy is going to rapidly recover, its dramatic selloff during the past year was exacerbated by fear (fear that the banks were collapsing and another depression was upon us). Both the optimism now and the pessimism exhibited in 2008 and early 2009 are examples of investor overreaction. Human emotions are why markets and investing can never be reduced to mathematical formulas. There is also no "reversion to the mean" (sorry equity strategists). Truthfully there is now "mean". The markets and economy are ever-changing. Each new reality is different from the one which preceded it.

Equities are not my forte'. Fixed income is my bailiwick. Take heed of my warning that many high yield bonds have rallied too far too fast. Which ones have gone too far? I wish I knew. There lies the rub. With corporate defaults still historically low, but expected to rise, there are probably more land mines ahead. As a bond guy many of my readers may not expect me to advocate bond funds (I really don't like funds or managers for fixed income investing), but since investing in high yield bonds is a speculative endeavor and is very equity-like strategically speaking, using a bond fund for high yield bond investors may be the way to go. After all, high yield bonds should be used as speculative total return instruments and not as income-generating vehicles.

The FASB passed regulations which will force banks to move off-balance-sheet assets (many of which are toxic or potentially so) onto bank balance sheets. This could put banks under renewed pressure. More on that tomorrow.