Where to Stash Your Cash Now

01/26/2010 1:00 pm EST

Focus: ETFS

Paul Justice

Associate Director of North American ETF Research, Morningstar, Inc.

Paul Justice, contributor to Morningstar ETFInvestor, tells where he’s putting his money in a challenging market where stocks have risen sharply while bond yields are very low.

Call me Mr. Obvious, but I’m guessing that most investors hope the next decade looks nothing like the last.

From 1926 through 2009, stocks have annually returned 9.8% and bonds 5.42%. From 2000 until 2009, equities lost 0.95% annually, while bonds gained 7.7%.

Compare that with the previous decade: From 1990 until 1999, stocks gained 18.1% annually, and bonds gained 8.8%.

[But] from a decadal perspective, the ‘00s hardly seem like a lost decade at all. Why shouldn’t a decade of 18% returns be followed by years of negative 1% returns if the long-term average is 9.8%?

Perhaps we’re just looking at simple mean reversion following a prolonged period of euphoria.

I ran a quick trend line chart over the same time frame for the Standard & Poor’s 500. Lo and behold, the market is within a few ticks of where the trend indicates it should be. If stocks are where they should be, investors should be neither heavy nor light in equities relative to their risk tolerance.

But stocks are only one side of the traditional balanced portfolio, so let’s look at the bond side. I remain doubtful that this decade will be nearly as kind to fixed income.

It doesn’t take a rocket scientist to figure out that 7%-plus returns are hard to come by when yields on moderate-duration bonds are close to 4%. If the inflation monster comes knocking, we may see a lost decade in fixed income.

So, if we have an equal weighting in equities but are pessimistic on fixed income, where should we put the remainder?

Investors deeply devoted to long-term passive strategies will tell you that the answer is simple: Do nothing. They say you should stay true to your allocations no matter what the fundamentals say.

However, my strategy veers on the fringes because of my pessimism on medium- and long-duration domestic bonds. Treasuries also offer me so little comfort these days that I see no more utility in money market funds than I do in storing my money under my bed.

Perhaps this is the reality of a lower-returning world that we’ve grown accustomed to over the past 28 years. If that’s what the market provides, there is little investors can do to fight it.

[So,] I will go light on fixed income at this point, and I’ll do it in the lowest returning portion—Treasuries. I am resigned to put my extra capital in alternatives and emerging markets.

Long-only commodity funds were pummeled by contango (a situation in which the futures price is above the spot price—Editor) last year, but our beloved ELEMENTS S&P CTI ETN (NYSEArca: LSC) escaped relatively unscathed.

This consumes most of our “alternatives” capital, and it should provide adequate protection should the monstrous inflationary environment so many economists promised ever materialize.

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