article 03-10-2015

"What has worked over the past few years… will almost certainly not work in the next cycle."

Strange things happen every day in the capital markets. Consider the recent fortunes for the 10-year Treasury, which hit a low of 1.68% on 1/30/15. (It reached an all-time low of 1.38% on 7/24/12.) Its yield then rose to 2.13% on 2/20/15—a nearly 27% increase in yield in three weeks. (The rate finished February at 2.00%, remaining volatile through the rest of that month.)

It's very interesting to us that the 10-year Treasury, a "risk-free asset," has been trading like a penny stock. What does that mean for other asset pricing? How does one assess risk in this environment? These are just a couple of the relevant questions many investors are asking at what we suspect is the tail end of one of the oddest periods in the history of the stock market.

The current, more volatile, less certain period seems to us to be a good time to heed the saying, "Past performance is no guarantee of future results." What has worked over the past few years, a period dominated by QE and ZIRP (zero interest-rate policy), will almost certainly not work in the next cycle.

The previous years’ market leaders—defensive and/or high-yielding areas such as REITs and Utilities and high-growth spots such as biotech and social media companies—now sport perilously high valuations in our estimation, even following February corrections. The key question, then, is what looks likely to take their place?

We have more to say on that issue here.

Important Disclosure Information

Francis Gannon is Co-Chief Investment Officer and Managing Director of Royce & Associates, LLC, investment adviser to The Royce Funds. Mr. Gannon's thoughts and opinions expressed in this piece are solely his own and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.

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