Risk-Adjust Returns Show Rational Investor Allocation

Markets continue to march higher as the Q2 earnings season gets underway.

The S&P 500 has returned roughly eight percent YTD. Investors have been correct in choosing equities and high-yield bonds and many participants are wondering how much longer those choices will outperform alternatives. 

On a risk-adjusted basis in fixed-income markets, global high-yield is outperforming government and investment grade credit, mortgage, and emerging market debt according to data from Capital IQ.

US large-, mid- and small-caps are outperforming alternatives such as global and EM stocks/real-estate on a risk-adjusted basis.
During the period of mid-year 2013, equities outperformed Treasuries, which was a period in time when the Fed started prepping markets for the QE Taper.

Cross asset class risk-adjust returns show high-yield taking the lead recently.

As for the influence the global equity rally has had on the credit component of high-yield assets, Capital IQ said, "The strong global stock market and its influence on the credit component of the high-yield market is positively influencing the risk-adjusted performance of the high-yield market, while global geopolitical instability and a general lack of economic vigor outside of the U.S. could be weighing on emerging debt."

The dampened risk-adjust return of the mortage market can be attributed to the generally flat US housing market along with the combined impact of the Fed taper.  

Furthermore, the marginally positive inflation-adjust Treasury yield, Fed taper and the ever increasing expectation of a Fed Funds rate hike in 2015 is cuasing serious damage to the risk-adjust performance of US investment grade yield curve.

Overall the crowd has rationally allocated capital to to US Large-caps over small-, mid-caps, overseas, or emerging market equities.  Questions remain regarding how much longer the crowd will continue to be correct and how well the crowd will allocate resources on a risk-adjusted basis.

The current environment of low rates and low volatility has driven investors to expose themselves to higher amounts of market and credit risk than they otherwise would.  

Benzinga previously noted the disconnect in judicious capital deployment because of cheap credit.  With the fiver-year Treasury inflation-adjusted returns near zero, citizens relying heavily upon investment income for household expense will be forced to incur higher risks in corporate bonds and equity markets, something that should be causing concern to the broad markets.  

The behavior of 2007 and the hubris asociated with it are back in full swing.