We humans are a curious bunch. Occasionally we say one thing but do another. Almost as often this gets us into trouble.

We sing the economic blues yet restaurant parking lots are packed. We cry over crushing debts yet vote for spend-happy politicians. We claim to be long-term, risk averse investors yet we chase performance.

As noted in our July 20th blog entry investors continue to pour money into asset classes with strong performance. Newly released data for July confirms the trend remains alive and well.

For the month ended July 31st taxable bond funds added $22.3 billion representing a 26.7% increase over June. Muni bond funds added $3.9 billion which is almost a doubling of June’s take. US and foreign stock funds saw outflows of $12.3 billion and $565 million respectively.

These numbers suggest risk aversion. If true then why did balanced funds shed $1.75 billion? Why did commodity funds add $923 million? Why did alternative investments add $1.6 billion?

The answer lies in performance. For the trailing 5-year period US stocks (as measured by the S&P 500) are off 12.3%. During the same period taxable bonds (as measured by the 10-year Treasury) are up 37.7% while emerging market stocks (as measured by the MSCI Emerging Markets Index) are up a whopping 70.2%.

Some may argue the shift to emerging markets is a flight to safety. With lower ratios of debt to GDP emerging markets may be viewed as a safe haven relative to the indebtedness of industrialized nations. If true it’s a stunning reversal in sentiment as 10-15 years ago many questioned the benefits of overseas investing given the dominance of the S&P 500. Remember the halcyon days of the .com era? US stocks offered upside and tranquility vs. the hemorrhaging of foreign investments. From the Asian contagion to the Russian default emerging markets lost 26.3% in 1998 alone. In 2008 they lost 54.4%. This is safety?

Some may argue the shift to bonds is a flight to quality but we question where it can be found. Massive Federal debt has resulted in expansion of the money supply and record bond issuance. At some point someone will notice the emperor has no clothes. No one will want to lend to the US. Debt will have to be paid – not financed. The resulting tax increases, spending cuts and printing of money will lead to inflation, depressed economic activity and carnage in bond markets. The handwriting is on the wall. There’s safety in bonds? Really?

The fact of the matter is return on bonds and emerging market stocks relative to US equities is the reason investors are flocking to these asset classes. Don’t let anyone tell you otherwise. The buy high – sell low mentality still dominates. How many times must investors be burned before we do as we say? If we’re truly risk averse is now really the best time to shy away from equities in favor of bonds and emerging markets? Who will we blame this time? It’s like watching a car accident about to happen and not being able to stop it.