While many investors have chosen to flee the volatility of equities in favor of the safety of fixed income instruments, market participants say it is only a matter of time before equities makes a comeback.
“Fixed income has been a great place to be over the last few years,” said Seth Merrin, founder and chief executive of dark pool operator Liquidnet.
“From a macro point of view, equities are in disfavor,” said Milton Ezrati, chief economist and market strategist with Lord Abbett, an institutional management firm specializing in equities and fixed income strategies. “The fund flows are all going away from equities and into bonds. However, time will prove that equities provide superior return compared to bonds. Investors will see that the so-called riskless asset is not riskless.”
With interest rates on the decline, fixed income instruments tend to become more valuable. But with current rates near rock bottom, the only place for them to go is up, and that will hurt bonds. While fixed income instruments are known to provide small but steady returns, under certain conditions, investors can begin to lose money on bonds.
“As interest rates and inflation rises, returns on fixed income will go down, which will be the catalyst for individual investors to return to equities,” added Merrin at Liquidnet
The overarching shift of investors from equities to other asset classes, including fixed income and foreign exchange, has been brought about in large part because of the ongoing financial crisis, which has lingered since 2008.
“Every decade has had its own financial crisis, and this one has been a real doozy,” said Merrin. “There have been more man made disasters in this last decade than any other. Investors have lost half of their savings twice, and then there have been events like the Flash Crash and the Facebook IPO—confidence has been down.”
Ezrati at Lord Abbett added: “Right now people don’t trust the system, they feel like the game is rigged. After 2008 and the bailouts, they are seeing many of the same people still in place, leading them to believe that people aren’t being punished for the financial crisis.”
Adding to the financial crisis most recently was the Facebook IPO, which was hyped up to be the saving grace for market confidence and was supposed to help bring back the retail investor. And while trading volume shot up during the May 18 offering, trading volume once again returned to normal levels the following trading day.
“The Facebook IPO was a complete mess from beginning to end,” said Larry Tabb, founder and chief executive of the Tabb Group, a consultancy. “It was a black eye for Nasdaq, market makers lost $100 million, investors paid too much. The original investors are still holding on to stock that is now $10 below the IPO price. Confidence is down—it’s a disaster.”
However, there are some positives to be gleaned from the incident.
“There is a silver lining to this, as it will make investors more careful in the future and to do thorough research,” said James Angel, professor of Georgetown University.