A very important point in the financial or real estate market is to understand that fear is a stronger emotion than greed and not lose your logical mind to emotions. Initially it is the greed factor that forces investors to participate in a bubble such as the current quest for high yield securities. These are the investors that lose the most amount of money by being the late buyers. To add insult to injury, they hold on to the asset as it suffers the post-bubble collapse. Eventually fear takes over logic, as they become extremely worried about the extent of their losses and, therefore, sell at the lowest possible levels.
The moral of this story is: do not allow your logical mind to be overridden by emotions, be it greed or fear.
Let’s look at the last bear market that started sometime during fall of 2007, and ended in March of 2009. By September 2008 most people were still ahead and not interested in selling. However, by February and early March 2009 their equity positions were down so significantly that they could not tolerate the pain of looking at their brokerage statement. So they sold at incredible bargain prices. That was selling due to fear of losing much more.
Basically, two types of people bought from these frantic sellers at 12-year low prices. First, the savvy investors who were mostly in cash during 2008 and had been around long enough to recognize the great bargains with a logical mind. The second group was mostly new to the market and did not have any negative baggage from the past. So they made logical decisions without any mental distortion.
Case in point is that the majority of the present investors in TLT and TIP (The US Treasuries), and high-yielding assets just haven’t experienced any major draw down. These folks are not battle tested. If the TLT drops below 110, they will start bailing out and force TLT to plummet to significantly lower prices. This also can transform the present bargain sectors (commodities) into winners especially if inflation shows its ugly head.
The net inflows into bond funds and other high-yielding assets during the recent months have been near all-time multi-decade extremes. The sole reason is that investors have perceived bonds as being “safe” and high-dividend equities as being the most reliable stocks. This has created a bubble: the yield asset bubble. Tread carefully. All it will take is a small trigger, such as an interest rate increase by the Federal Reserve, to burst this bubble.
If you are not currently invested in U.S. Treasuries, bonds, high-yielding assets like REITs, utilities or consumer staples, avoid being pulled into the greed of these overcrowded trades. The eventual downturn of these securities will signal the beginning of an important bear market which could go on for two to three years. Remember, investors with the least emotional behavior are most likely to have the best long term track record.