Eighteen months into the worst bear market since the Great Depression, investors seem divided into two camps: those who have thrown in the towel and those who are getting ready to throw in the towel.
Adding fuel to the fire is my old friend Bill Gross, the chief investment officer of Pacific Investment Management and the world's most powerful bond investor. The "bond king," as I dubbed him in my eponymous book, announced "the death of equities" in an interview published last month on the Daily Finance Web site.
As the Web site FundAlarm pointed out almost immediately afterward, we've heard this argument before, most famously in 1979 from BusinessWeek magazine. Its death-of-equities cover story was belied by the biggest bull market in history shortly after the magazine rubbed its face in this egg.
Last week's explosive -- and global -- rally might already be proving current pessimism wrong. Even if they're not at their ultimate bottom, however, the fact is that the choicest assets in the world, from oceanfront villas in the Hamptons to sweet crude oil in west Texas, are marked down to pennies on the dollar.
Markets are so low -- and I mean all markets, every single one except U.S. Treasury bonds -- that making a fortune over the next five years will be easier than shooting fish in a barrel. Indeed, you don't have to aim at individual fish; hitting the barrel will be enough to shower you in money.
And there are lots of barrels to shoot at. Here are three with the biggest bull's-eyes painted on them.
Undead equitiesAt their nadir before last week's rally, domestic markets were down more than 55% from their peaks in October 2007. Some sectors have done even worse, most notably small-company and financial stocks.
But corporate profits haven't gone down that much. The extra drag on stock prices has been the decline of price-to-earnings multiples, to about 11 times this year's expected earnings from around 20 as recently as 2003 and nearly 30 in 1999.
That tells me a big part of the rout in stock prices has come purely from emotion. These are the "animal spirits" that John Maynard Keynes spoke of, that economist Robert Shiller has revived in his latest book and that Gross specifically referred to in his Daily Finance interview. "Risk taking has been destroyed," he said, "and any animal spirits must come from Washington."
But animal spirits were abundant and universal last week, with world exchanges going up as much as 5% day after day. In fact, when the news was issuing only from Washington, D.C., animal spirits were well bottled up. It wasstatement that its earnings were less awful than expected that sparked the big rally.
How to ride it? Like a tsunami rather than a trifling wave. Simply get on board, no finesse required. The barrel is "the stock market," so buy a whole index. Every 401(k) plan offers such an option; the biggest is Vanguard 500 Index Fund Investor Shares (VFINX).
The ultimate one-stop solution is theexchange-traded fund, which has roughly half its assets in the United States, 40% in the rest of the developed world and 10% in emerging markets.
Of course, this rally could be temporary, what's known as a bear market rally. But the earnings data tell me that, long term, we're not going much lower, and we won't stay lower.
Bully bondsThe only assets in the world that performed well in 2008 were U.S. Treasury bonds and only because they were utilized as the ultimate safe place to keep money. More than once, the Treasury paid little or no interest on three-month bills, so great was the demand for them. American Century Target 2025 (BTTRX), which owns only zero-coupon, long-term Treasury bonds, shot up 26.5% last year.
Investors didn't desert just stocks to buy Treasurys; they abandoned other bonds, too. Corporate bond funds sank an average of 6.8% last year, according to Morningstar, and municipal bond funds fell nearly 10%. The average junk bond mutual fund tumbled 26.4%.
Foreign bonds were also laggards, partly because the flood of money into Treasurys sent the U.S. dollar higher., representing developed markets' sovereign debt, was down 4.2% in 2008. tumbled 18.8%.
Already this year, some of the air is being let out of the bubble in Treasury bonds. As debt markets turn toward normality, last year's laggards will be this year's winners. Once again, the bond barrel is so big and inviting a target that you don't have to burrow down to subcategories to find opportunities. Any decent non-Treasury bond fund is a good candidate.
And most investors, including 401(k) investors, have access to multisector bond funds, which allow their managers to cherry-pick elements of the overall market. They had a lousy year in 2008, mainly because of the wipeout in high-yield bonds, but as a group they're doing well this year. I own one of these, T. Rowe Price Spectrum Income (RPSIX).