I believe it is the heavy reliance on model-driven total return strategies behind the warped manner in which fixed income is often viewed/assessed, today. An article in today’s Wall Street Journal discusses the deluge of money flowing into the municipal bond market. In spite of the obvious reasons investors have for moving capital into municipal bonds, some market participants cannot see the logic in doing so. The Journal quotes James Kochan, chief fixed-income strategist at Wells Fargo Funds Management as saying:

“It doesn’t take much to produce negative returns from these levels.”

Oh brother! Few investors seek high total returns when investing in municipal bonds. Forgive me for stating the bleeding obvious, but most municipal bond investors do not seek capital gains. They seek tax free income and preservation of capital. Thus, it does not matter much if interest rates rise, fall or stay the same, if one is willing to hold until bonds mature or if they are called.

I believe what is being missed by wealth management investment strategists (at least until recently) is the impact demographics are having on asset allocations and capital flows. Aging demographics and a growing concentration of investible wealth in among the elder demographic has changed the landscape for asset allocation, capital flows, credit spreads, bond yields and even equity P/E ratios.

The current equity bull market has been described as the most unloved bull market on record, by many investment strategists and market participants because of the lack of participation by retail investors (in fact, retail investors have pulled capital out of the equity market in recent years). Either these commentators are dense or disingenuous (I will let you decide which is worse). The unloved bull market is a demographic story, in my opinion.

As investors age they tend to become less growth oriented and more income oriented. This usually means higher fixed income allocations and lower growth equity allocations. If the bull market was truly unloved I doubt that that dividend paying-stocks would have experienced the strong demand seen during the past several years, a time when many investment strategists did their best to steer investors away from asset classes with high levels of interest rate risk, including dividend-paying stocks.

Last week, I met with a former Smith Barney colleague who now owns his own investment firm. He told me that the firm has experienced an increase of investor concern regarding what their monthly income might be. Aging investors care less about what their annual total return is and care more about what their income should be. The older investor demographic is becoming increasingly concerned about burning their principal and outliving their money.

My view is: The current equity bull market is just as loved as previous bull markets, but there are fewer investors who can share the love. I believe that P/E/ ratios among dividend-paying stocks should remain higher than what has been typical. Ccorporate credit spreads and inflation breakevens should remain tighter than normal for the foreseeable future. Municipal bonds should continue to experience robust demand as a growing investor cohort demands tax-advantaged income and, in some cases, alternatives to U.S. Treasuries.