Markets don’t know how to define ‘safe’ now

If the recent selloff in markets proves anything, it’s that for too many years too many people were focussed solely on returns with zero consideration for risk or safety. The last time anyone really thought about safety in markets was during the financial crisis more than a decade ago, when investors couldn’t get enough government bonds or cash.
But as the economy recovered, so did investors’ appetite for risk. A sort of cult of equity developed, with the unshakable belief that stocks would keep going up, and if they ever went down — which they did fairly sharply in the second half of 2015 and the end of 2018 — they would always come back — which they always did. “Buy the dip” became an actual strategy. The American Association of Individual Investors found that its members had an almost 66% allocation to stocks in December, up from 41% at the bottom of the financial crisis.
More importantly, the definition of safe morphed as stocks soared to new heights. If you went to your financial advisor and told him or her that your risk tolerance was low, he or she probably would have put your money in a portfolio of stocks that had a history of rising, not because they had any defensive qualities. But as we have seen this month, all stocks can go down with equal ferocity. That cult of equity has been shattered — perhaps permanently.
The prevailing feature of this bear market is that nothing has really been safe. If you had any exposure to bonds, it was probably in the form of investment grade or high-yield, high-risk debt, which were down almost as much as stocks until the stimulus packages from the government and Federal Reserve. And nobody contemplated a scenario where municipal bonds would not be safe. General obligation munis are backed by the unlimited taxing power of municipalities, but yet they were not spared, and that market ceased functioning.
US Treasury notes and bonds did provide some diversification benefits, but only to a point. After yields bottomed a couple of weeks ago, a massive unwinding of certain trades and the promise of massive government borrowing to fund the fiscal rescue plan drove yields higher. For decades, bonds mixed with stocks was good enough to achieve diversification, but will probably be less useful going forward.
Gold has been a bit of a disappointment. The whole reason people buy it is for situations like this, and it hasn’t worked, initially taking a big dive from about $1,680 an ounce to $1,471 in a matter of weeks. Although something similar happened in the last crisis, with gold peaking early at $1,000 as Bear Stearns collapsed, and then proceed to go down as the financial system unraveled, before finally turning and surging to $1,900. Although gold has rebounded somewhat, those expecting gold to go up when stocks went down were let down. Similarly, Bitcoin has also been less than underwhelming. The digital currency, which sometimes trades like a haven asset, has mostly traded as a risk asset instead, though it has also recovered somewhat just like with gold.
Money market funds are struggling to avoid a situation like what happened in 2008, when the Lehman Brothers bankruptcy caused the Reserve Primary fund to “break the buck,” which led to a run on money market funds. The commercial paper market is smaller than it used to be, but money market and ultrashort duration bond funds don’t strike as very safe here without help from the Fed.
—Bloomberg