241 years ago, Lord Cornwallis surrendered to George Washington on the plains of Yorktown, Virginia. 10,000 British troops were captured, effectively ending the Revolutionary War. Tradition has it that during the formal surrender ceremonies, the British band played the ballad, “The World Turned Upside Down.”
Has asset management turned upside down? The riskiest assets are deemed safe, and the safest are certifiably risky. Cash, considered the safest of safe havens, is losing value relative to inflation. Inflation has been running between 2 and 2 ½ percent, but since late 2008 cash has paid almost nothing. Short-term bonds of other AAA governments are trading at negative nominal yields.
At the same time, investors are being encouraged to invest in stocks for their income stream, treating some high-dividend stocks as if they were variable-price bonds, and looking to high-yield debt and even emerging market debt as a safe haven against the political turmoil and long-term fiscal issues facing the US and other developed nations. After all, the populations and economies of the developing world are growing
But high-yield debt can default, and emerging market nations can do irrational things, as recently happened when Argentina seized control of the an oil company to avoid an energy crisis—without compensating the owners. Political risk and default risk are real, despite interest rates insure a loss of purchasing power. Meanwhile, stocks are still the last link on the corporate cash-flow food chain. If anything happens with pension funding or tax payments raw material costs, those dividends—which aren’t contractual—could be cut.
So the risk hierarchy—cash, bonds, stocks—hasn’t been inverted, and the rules of asset management haven’t been repealed. We’re living through an historic period of financial deleveraging and slow growth, in the midst of continued globalization and financial liberalization. The first rule of risk management is still to focus on the safe return of your money, not just the return on your money.
Douglas R. Tengdin, CFA
Chief Investment Officer
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