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When money takes flight

By Dr. Don Taylor · Bankrate.com
Tuesday, March 11, 2014
Posted: 6 am ET

When money seeks safety, it's called a flight to quality. The U.S. Treasury market experienced a flight to quality with the threat of Russian military activity in Ukraine on Monday, March 3.

A classic flight to quality focuses on shorter maturities, like Treasury bills, but investor interest can expand out to longer maturities, like the 10-year Treasury note. Interest rates are so low in U.S. Treasury bills that it's not much fun to talk about what's happening in T-bills unless the yield turns negative, which is when you pay the government to loan them money. That's a topic for another day.

The increased demand raises Treasury prices. Rising prices mean falling Treasury yields. The 10-year Treasury saw its yield fall to 2.6 percent on Monday, March 3 from 2.66 percent on Friday, Feb. 28. The goofy part is that a day later, March 4, the 10-year was priced to yield 2.69 percent. That 0.09 percent jump was the largest increase in yield since Nov. 20. Tensions had eased somewhat in Eastern Europe, but you wouldn't expect a flight to quality to be that short-lived.

What happened? The easing tensions made U.S. equity investors willing to invest in stocks. The stock purchases had to be financed somehow, so Treasuries were sold to finance stock buying. Treasury prices fell on the sales, raising their yields.

Traders talk about "risk on" and "risk off" trades. A flight to quality is a "risk off" trade, while moving money into stocks is a "risk on" trade. The head scratcher here is how tensions can ease enough in a day to have the U.S. stock market, as measured by the Dow Jones industrial average, score its largest one-day gain since December, reversing a 154-point loss the day before.

For most investors, this is just noise. They have an investment horizon that is long enough that they shouldn't focus on the day-to-day machinations of the market. So, why write a blog post about it?

What has me focused on it is the second chance a flight to quality can give to fixed-income investors who want to reallocate their bond investments.

The expectation is that the end of the bull market in bonds is near. The problem is that economic uncertainty and political unrest can continue to drive yields lower, resulting in higher bond prices. Investors who expect yields to go higher and want to shorten the average duration of their fixed-income holdings are being given a second chance to do it.

On the equity side, the bull market is getting pretty long in the tooth. Buying in at these record levels carries its own set of risks as I discussed in an earlier blog post, "Buying high, aka upside capitulation."

How often do you monitor the markets and your portfolio? When's the last time you rebalanced your portfolio? What gets you to change your asset allocations?

Follow me on Twitter: @drdonsays.

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