“The whole idea that the stock market reflects fundamentals is, I think, wrong. It really reflects psychology. The aggregate stock market reflects psychology more than fundamentals.”
Robert Shiller, Nobel Prize-winning economist
Tired of low returns? You may be a bond investor.
Bond investors have been “growing tired of low returns, the endless warnings that rates are about to rise, and constant reminders of the dangers of riskier bonds,” according to Jeffrey Matthias, CFA, CIPM of Madison Investment Advisors.
At the same time, they’ve watched the stock market continue to break new records every time there’s another sign that a central bank somewhere may buy a few bonds or lower interest rates into negative territory.
“None of us have ever lived through this kind of extreme, long-lasting suppressed rate environment,” Matthias wrote, and, as a result, those bond investors who are mad-as-hell-and-are-not-going-to-take-it-anymore have been frustrated enough to take on a lot more risk for a little more yield. 
When you chase yield, you catch risk. It’s a dangerous reaction to the yin and yang of investing – fear and greed.
“Typically, when markets are moving higher,” Matthias wrote, “most investors turn greedy and want more. Should an investor’s more conservatively positioned portfolio produce lower returns when the market surges, the investor may regret not having taken more risk. In contrast, should a riskier portfolio drop significantly in market value, the opposite may happen and an investor may begin to regret (his or her) decision to have invested in risker assets. This can be accompanied by a fearful overreaction.”
So what should you do if you’re mad-as-hell-and-are-not-going-to-take-it-anymore?
Remember to diversify. And keep risk in mind when you do. You have stocks, which have the potential to achieve high returns (in this market, only as long as investors are willing to continue to delude themselves), but stocks, as an asset class, carry significant risk.
And you have bonds, which are typically the boring, staid, not-too-exciting, but not-as-risky part of your portfolio. Thrill-seeking investors can get plenty of kicks from the gyrations of the stock market, assuming they have a significant percentage of their assets in stocks. Adding risk in the current market by investing in junk bonds and bonds with long-term maturities is inadvisable.
If your stock investments aren’t giving you enough risk, take up skydiving or maybe bungee jumping. While no one can predict the future, this isn’t likely to be a great time to get daring with your bond investments.
Predictions of rising interest rates will eventually come true and the great easy money experiment that has juiced the markets for the past six years will end. When that happens, bond investors who took outsized risks could be among the casualties.
Other Pessimists
This blog is not known for its optimistic outlook. We see our job as Cassandra-like, warning of imminent danger, but hopefully with greater credibility. While risk is necessary to achieve reward, avoiding loss is sometimes more important than missing out on short-term gains.
So we view economic growth numbers, unemployment stats and other economic data with a bit of cynicism.
Yet we’re sunshine and roses compared with David Stockman, director of the Office of Management and Budget under President Reagan. In the context of “greed and fear,” his finger is squarely on the “fear” button.
In a recent entry on his Contra Corner blog, he makes the argument that the financial crisis was construed as a way to self-serving dealings at AIG with credit default swaps. It then became the catalyst for the Federal Reserve Board’s initial bond-buying program, which itself became the catalyst for the easy money policies of central banks around the world.
“At the time of the crisis,” Stockman wrote, “the combined balance sheet of the Fed, ECB and BOJ was $3.5 trillion or about 11% of GDP. In short order that number will reach $11 trillion and 30% of the combined GDP of the so-called G-3.
“Throw in the BOE, the People’s Printing Press of China, the bloated central banks of the oil exporters and Russia and assorted others like the reserve banks of India and Australia and you have total central banks footings in excess of $16 trillion or roughly triple the pre-crisis level.”
He wrote that this “tsunami of central bank credit did little for the real economy in places where the private sector was already at ‘peak debt,’ such as the U.S. and Europe, … But what it did do universally and thunderously was to fuel a financial asset inflation the likes of which the world had never before seen.”
“Even more crucially,” he continues, “capital markets were transformed into rank casinos that were virtually devoid of all economic information … except, except the word clouds, leaks and sound bites of central bank speakers and their tools in the press and monitors in the banks, brokerage houses and hedge funds. At length, this meant that the only reason to buy was that virtually every risk asset class was rising; and it also meant that the only risk worth worrying about in a day-trading market was from the verbal emissions of central bankers and their Wall Street accomplices and stooges.”
So today, while central banks have lulled investors into a mind-numbing calmness … 
… Stockman is painting an end-of-days scenario.
He notes that “there are financial time bombs planted everywhere in the world economy because central bank financial repression has caused drastic mispricing of nearly every class of financial asset … “
And he finally concludes that “what is happening now is that risk is coming out of hiding; the collateral chains are buckling; the financial time bombs are beginning to explode … “
“Moreover, the central banks are now out of dry powder – impaled on the zero-bound. That means any resort to a massive new round of money printing cannot be disguised as an effort to ‘stimulate’ the macro-economy by temporarily driving interest rates to ‘extraordinarily’ low levels. They are already there.
“Instead, a Bernanke style balance sheet explosion like that which stopped the financial meltdown in the fall and winter of 2008-2009 will be seen for exactly what it is – an exercise in pure monetary desperation and quackery.
“So duck and cover. This storm could be a monster.”
We hope that he’s wrong. But, just in case, you may want to read what he has to say before you consider chasing yield.