Why you shouldn't buy bonds anytime soonApril 11, 2012: 5:00 AM ET
You'd have to be a psychic to know where stocks are headed, but you don't need a crystal ball to know that corporate bonds are a bad bet.
FORTUNE -- It's one of those eternal truths. Just as you can be sure that daffodils and forsythia will blossom this time of year, you can be sure that mutual fund investors will collectively act like blooming idiots by doing the wrong thing with their money.
Take the recently completed quarter, in which the Wilshire 5000 total U.S. stock market index was up a nifty 12.25%, its best Q1 since 1998. What were mutual fund investors doing? Selling U.S. stock funds, which were rising nicely and have a reasonable chance to climb over time, and loading up on bond funds, which are almost certain to decline over the long haul. Investors were net sellers of $15 billion of stock funds for the first three months of this year, according to the Investment Company Institute, and net purchasers of $77 billion of corporate bond funds.
But, you say, don't we keep hearing that the U.S. stock market is richly priced? Aren't U.S. stocks, which have more than doubled from their 2009 lows, being driven largely by the huge Apple bloom -- oops, boom -- that has made Apple the most valuable company in the world? Apple, (AAPL) up 48% in the first quarter, in fact accounted for a disproportionate part of the gain -- but as we'll see later, not an insanely disproportionate part.
It's not clear to me where U.S. stocks will go from here -- if I knew for sure, would I be writing for a living? However, it is totally clear where yields on investment-grade corporate bonds will go from here. Up. Not necessarily tomorrow, though rates have been ticking up since mid-March. And not necessarily next year. But rates are certain to rise, which will inflict substantial losses on the investors piling into corporate bond funds seeking safety and reliable income. Remember your Investing 101: If bond yields rise, the market price of existing bonds falls. You can hold individual bonds to maturity and get your principal back if the issuer doesn't default. But bond funds never mature. It's fine for sophisticated investors to try to time the bond market -- it's a whole other thing for amateurs like us to try it.
Most people don't realize how far corporate yields have fallen, because you don't get much day-to-day news on them, the way you do with stock prices and yields on Treasury securities. Guess what? Investment-grade bond yields are at multi-decade lows. The March yield on Moody's Aaa-rated corporate bonds -- the top tier -- averaged 3.99%, the lowest since 1958, according to data from the Federal Reserve. The yield on Baa-rated corporates -- the lowest investment- grade rating -- was 5.23%, the lowest since 1966. These are down from 5.13% and 6.03% a year ago, and 5.50% and 8.42% in March 2009, when stock prices bottomed.
Unless bond yields fall to zero, which can't happen, there's not much upside left for bond fund investors. There's an awful lot of downside, though, because yields are being held artificially low by the Federal Reserve, which won't -- and can't -- keep doing that forever. When the inevitable rise hits, prices of bond funds will drop.
And now, a word on Apple, to help keep the stock market in perspective. According to Bob Waid, a managing director at Wilshire Associates, Apple's 48% run-up boosted the Wilshire 5000 by 0.91% in the first quarter. Thus, Apple accounted for about 7.4% of the aforementioned 12.25% first-quarter increase. This means that the other 3,718 stocks in the index accounted for almost 93% of the gain.
Besides, although Apple is a really important stock, the market's destiny doesn't necessarily depend on Apple. On Dec. 27, 1999, Microsoft (MSFT) -- then considered the will-never-ever-miss growth stock -- was valued at $615 billion, more than the $559 billion at which Apple ended this past quarter. Microsoft was worth less than half its peak value -- $271 billion -- this past quarter end, but the Wilshire was up 7% for the period. Not great, to be sure, but not disastrous. The moral: Just as forsythias and daffodils aren't the whole garden season, Apple isn't the whole stock market. Happy spring.
Reporter associate: Doris Burke
This story is from the April 30, 2012 issue of Fortune.