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Part 2 - Bubbles, Bonds & The Allocation Dilemma

As we mentioned in part one of this article last week, wealth management firms are managing a cross-section of economic conditions and asset classes that each carry comparative risk. We define comparative risk as the "opportunity cost" of asset allocation in which "yield" is the primary measure by clients.

How much "risk on" or "risk off" is the asset allocation question in the midst of what are inevitably "unknown timeframes" and economic conditions that can outlast any rational mind.

In this article we will talk about some other dilemna's facing wealth management firms and their clients:-

The Chasing Yield Dilemna

Where do investors go to get relatively low risk stable inflation beating yields today? Not in Bonds. Even with rising bond yields in the last weeks, they are unlikely to beat inflation. Low risk, inflation beating yield assets are hard to find.


The Big Market Picture Dilemna

Wealth Management necessitates risk mitigation while adapting to market conditions. Navigating market conditions with negative inflation yielding bonds, stocks in the historic high range of valuations, cash allocations that are subject to negative yields albeit necessary to any portfolio, and alternative asset classes that carry high risk and volatility makes for a very challenging decision making framework that requires vigilance and stealth.

Asset bubbles can go on much longer than one can foresee. In fact analysts were calling the Dot Com a bubble in 1995, five years before the bubble burst. How long will this bubble continue?

Being out of the market for years touting "bubble conditions" can be costly for your clients if such a bubble goes on for another 2-3 years. The final phases of any bubble can be the most profitable. So, how do you allocate risk in a way that retains clients trust and returns. That is a significant dilemna for wealth managers in todays market conditions.

Banks are, in recent weeks, clearly pushing for a new narrative. With long term low yields and interest rates come massive undesirable bubbles for many asset classes with limited supply. It's not a sustainable macro economic scenario. Hence the strategy of rising rates on longer duration bonds to shift some risk out of bubbling asset classes and slow them down. Will putting the foot on the brakes work? To a limited extent it may work short term but with so much excess stimulus moving into the economy it is unlikely to slow market conditions anytime soon. 

Inevitably, every bubble has it's final euphoric rise before it bursts, when even the most optimistic traders and investors cannot justify buying as conditions no longer warrant even their optimism.

There are no easy answers on how to allocate capital in these unqique market conditions. Hard decisions have to be made that provide a personalized risk mitigation strategy. It is not so much about outright winning as it is about preserving capital and capital gains on balance with the capaability to have sufficient capital/cash on hand to pick up assets when they have been de-inflated.

The question you need to ask yourself is: Are you and your portfolio prepared for when this bubble bursts?

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Bubbles, Bonds & The Allocation Dilemma - Part 1

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Walnut Creek, CA 94596
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