Trader’s Narrative

Last year US investors funneled their cash to bond funds at such a rate that managers of these funds have not been able to put the new pile of assets to actual use. This has lead to the liquidity ratios at bond funds to reach historic levels not seen in 5 years:

The charts are courtesy of Gluskin Sheff, the Canadian asset manager where David Rosenberg hangs his hat these days. Rosenberg, by the way, believes that this reflects a secular shift in the asset allocation of US investors:

More than 25% of the household asset mix is still in equities; ditto for real estate. But less than 7% is in the broad fixed-income market. That is the part of the asset mix that is expanding the most, and sorry, this is not some sort of ‘contrarian’ call for the equity bulls but rather a sign, yet again, that a fundamental shift in behaviour is taking place. Get on the bus or you will be left behind.

The flow of cash towards fixed income shows no signs of abating. In December 2009 more than $31 billion went into bond funds (taxable and municipal). With the trend and the amount of cash sitting on hand for the managers to use, there is a strong and constant bid under bonds.

I continue to believe that this mad rush will not profit the average US investor. In the past, every time bond’s have been priced at these levels, their future returns has been abysmal. Smart bond trades like PIMCO’s Bill Gross have already lightened up in anticipation. But there is no use in arguing with a trend once it has started to build momentum. And there is no logic that would sooth the raw nerves of those who have seen their nest eggs devastated during the recent bear market.

And in case you’re curious what the liquidity ratio of equity mutual funds is like, here’s a chart:

For a more detailed analysis see our previous discussion of it:

• Mutual Fund Cash Levels (Adjusted for Inflation)
• Mutual Fund Cash Levels & NYSE Free Credits