Americans, on the whole, just aren't excited about the stock market or investing right now. I can't blame them.
The tech bubble that had us all chasing hot stocks popped more than a decade ago. Since then, recessions, volatility and a go-nowhere market have all but killed the idea of buy-and-hold investing -- buying great stocks and waiting for a run-up -- because you can wait only so long.
In fact, there's been a historic shift away from stocks in the past decade. Many investors have sought the perceived haven of bonds. Many others have stopped funding their retirement portfolios altogether. The national retirement income deficit, or the amount potential retirees still need to save to cover basic expenses and uninsured health care costs, stands at a whopping $4.6 trillion, according to the Employee Benefit Research Institute.
I'm here to tell you it's still possible. You can build a million-dollar 401k. You're likely going to have to reconsider your strategy, save more and take more risks. But the good news is that investors can look forward to what's shaping up to be the best market environment in a generation.
Havens that aren't
I know you're skeptical. To be sure, these are still scary times. And you're on your own.The shift to 401k's and other self-funded retirement accounts -- requiring us all to manage our own retirement portfolios -- began in the 1980s. But it's hard to separate it from the context of the past 10 years, which saw the worst stock market performance since the Great Depression. At the same time, Wall Street professionals have given us every reason to believe that growing our stocks is not what the game is about.
It can feel like you've been blindfolded, pushed into shark-infested waters and told to swim to shore.
That's why we've seen the average investor shun risk and embrace bonds.
But with Treasurys yielding just 2.4% a year and inflation expectations nearing 2%, the 0.4% real yield they offer isn't going to get you anywhere near that $1 million goal. Investment-grade corporate bonds aren't much better, offering just 4.5% at the expense of added risk.
That leaves investors with little choice but to seek out higher returns in riskier assets. By that I mean stocks.
The bond binge
Yet vast sums of money continue to be pulled out of equities, with more than $49 billion coming out of U.S. fund groups so far this year. Destination: bonds and bond funds, which have received more than $180 billion in fresh capital so far this year.Because of this, U.S. household exposure to bonds versus equities has moved to levels not seen since the mid-1990s.
In the chart below, you can see how bonds are coming off their best relative 10-year performance against equities since the late 1930s. Yep, that's right: Bonds recently outperformed stocks by a margin not seen since 1939, when Nazi Germany was on the march and the U.S. economy was recovering from 1938's double-dip recession.
(The chart uses the rolling 10-year total return for the S&P 500, which has been backdated into the 1800s by the folks at Global Financial Data.)
The bond boom is showing signs of speculative excess not unlike the technology bubble of the late 1990s. In fact, the recent pace of bond inflows has increased dramatically as performance chasers have thrown cash at the asset class. Barclays Capital strategist Edmund Shing notes that over the past two years, cumulative bond inflows have climbed over $700 billion. This is the same level of inflows that marked the top of the equity bubble in 2000.
Against this backdrop, if either economic growth or inflation surprises to the upside, bond investors could face a rout on a scale not seen in 60 years. Interest rates would rise, sending bond prices plunging in response.
That's exactly what happened in the 1950s when the Federal Reserve stopped buying Treasury securities in the wake of World War II. Bond yields moved higher as economic growth and inflation both increased, pushing bond prices down 24% between 1945 and 1959 before ultimately falling 56% into a bond market low in 1981. We face a similar risk now.
Continued: Focus on performance
