What Did You Learn In 2012?

Seth J. Masters, Chief Investment Officer of AllianceBernstein's Bernstein Global Wealth Management, reflects on the year that was.  His opinions are his own.

This year, investors worried about the future of the euro, the US fiscal cliff and the emerging-market slowdown…yet stocks still climbed higher. What lessons should we learn from 2012? We’d suggest four key takeaways.

1.       Investors can get trampled in crowds

Many pundits proclaimed this year that “equities are dead,” and that investors should look to other asset classes. Many investors took this advice and liquidated almost $80 billion of equity funds (net) in the first three quarters of 2012. Following the crowd by dumping equities proved unwise. The S&P 500 has returned about 14% in so far 2012, and equities are still alive and well. It’s natural for investors to be jittery in volatile markets, but joining the crowd will not necessarily take you in the right direction.

2.         If it walks like a bubble and talks like a bubble, it probably is a bubble

Investors were caught off guard when the tech bubble collapsed in 2000. In 2012, was a new bubble—in supposedly safe assets—created? Let’s look at the facts: Despite 10-year US Treasury yields below 2%—their lowest level since 1791—investors seeking safety funneled some $240 billion into US-domiciled bond funds in the first three quarters of 2012. They also snapped up high-dividend-yielding stocks, driving their relative valuations 50% above their historical norms. This willingness to pay a premium for safety certainly walks and talks like a bubble. Do investors want to stick around in 2013 to find out if it is one?

3.       Traditional tax advice was turned on its head

When it came to tax planning in 2012, the traditional rules did not apply for US investors. Normally, it makes sense to delay capital gains for as long as possible and to harvest long-term losses to offset long-term gains. But with an almost inevitable rise in the capital gains tax next year, US investors may fare better by holding onto their losses and harvesting gains instead. Now is one of those rare times when it might make more sense for them to pay taxes sooner rather than later.

4.       Passive management is not risk-free

Passive management has been in favor the past few years. From 2008 through 2012, US-domiciled passive equity funds had inflows of more than $200 billion, while active equity funds had outflows of about $450 billion.

But by piling into passive portfolios, investors may have unwittingly taken on undue concentration risk. Here’s why: When the market becomes overly enthusiastic about a particular market segment, that segment’s weight in the market index can become very large. That’s what happened to tech stocks in 1999: They rose to over 29% of the S&P 500. Investors in passive strategies later suffered sizable losses as the tech sector shed 56% of its value.

Today, investors could be in the same boat. The S&P 500 is dominated by high-dividend-paying stocks. The 20% of stocks with the highest dividend yields made up 44% of the index at their peak a few months ago. That’s the highest weight since 1970 and far above their 35% average weight since then. Meanwhile, deep-value stocks (the 20% of the S&P 500 with the lowest price-to-book-value ratios) have fallen to just 25% of the index, close to their low point and well below their 31% average since 1970. Investors who buy into the S&P 500 today will own more stocks that are trading at a premium relative to their history and many fewer that are cheap. It certainly looks like a passive strategy could carry a lot of risk.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.