By Tom Bradley

My last post on gold spoke to the impact of investor sentiment on security prices. In the case of the shiny metal, sentiment is everything. As for other securities, such as bonds and stocks, it’s a secondary factor - economic fundamentals (profits) and valuation drive the boat.

Having said that, I find the market sentiment in the fixed income markets to be remarkable. I say that because the consensus around interest rates has two elements to it. One speaks to valuation (rates are unsustainably low) and the other to timing (rates won’t rise for a few years to come). In other words, the market thinks bonds are expensive now, but because of macro-economic factors, they’re going to stay that way for a few more years.

I bring this topic up again (and again and again) because investors have to be careful when valuation and sentiment are at extremes. Betting with the consensus is a hard way to make money at the best of times, but when it lines up with valuations being out of line, it can set the stage for a wild ride … in the wrong direction.

Hopefully, gold has served as a wakeup call when it comes to investor sentiment and strong consensus. That is: it will change; we won’t see it coming; and we won’t know why until after the fact.

The catalyst for higher interest rates could be any number of things – higher inflation, a better economy, rising stock markets. When long-term Government of Canada bonds lose 15% of their value, we’ll be saying, “What were we thinking … bonds were ridiculously expensive and everyone loved them!”

So beware of complacency. We are in unprecedented times when it comes to government finances and monetary stimulation. Other than the Leafs making the playoffs, we shouldn’t be too confident about anything right now.

Note: In response to the interest rate complacency, and valuations for the bonds and stocks, we have positioned the Founders Fund (and advised clients in relation to their long-term asset mixes) to carry a minimum weighting in bonds and hold some cash and short-term investments instead (10-15%). As for the bonds we hold, our manager, Connor, Clark & Lunn, is heavily tilted towards corporates, with little or no exposure to Government of Canada bonds. We’re recommending a regular allocation to stocks, but with a tilt towards foreign stocks over domestic.