WHAT MAKES ME strong in my convictions is that I’m always ready to abandon them. As a trader, I have no allegiance to one stock, sector, analyst, idea or asset class. My only loyalty is to the bottom line.

And while we are influenced by the past, we live and trade in the present. TV’s talking heads have an explanation for everything, but the truth is there are no rules for how the market “should” act.

So in positioning my portfolio, I start by erasing any preconceived notions about how a trade might turn out. It’s a technique that entails keeping not only your eyes open, but your mind as well. In short, assume nothing. When everybody knows something is so, it usually ain’t.

One of the things everybody knows is so: When the Federal Reserve cuts interest rates, the stock market rises. But after six rate cuts and seven months, the big caps are still underwater year-to-date. Fighting the Fed hasn’t exactly been that bad a strategy lately.

Another mistaken assumption is that a successful company equals a successful stock, when, in fact, a company and its stock are actually two very different animals. But it’s that simplistic logic that led people to take huge positions in Cisco Systems (CSCO) because “the Internet isn’t going anywhere,” or to buy Palm (Palm) the day it went public because they “believed in the product.” If only it were that easy. There’s a reason we haven’t seen Peter “Buy What You Know” Lynch’s smiling face recently.

But perhaps the most dangerous article of faith is that equities will continue to be the best-performing asset class over the “long term,” or at least over their own individual holding period. It’s a commonly held view among investors of all sizes, from Joe Sixpack to Joe Battipaglia. Even a 60% haircut on the Nasdaq hasn’t really shaken this faith. When it comes to overall asset allocation, equities continue to dominate most people’s portfolios.

Let’s start with the pros: Tom Galvin, market strategist at Credit Suisse First Boston, recently reduced his earnings estimates on the S&P 500 but maintained his firm’s model portfolio of 70% stocks, 20% bonds and 10% cash. UBS Warburg’s U.S. portfolio strategist, Ed Kerschner, also cut his 2001 earnings outlook but kept his model portfolio 77% in stocks, 18% bonds and 5% in cash. Cautious on the economy perhaps, but still very bullish on equities. J.P. Morgan Chase’s chief portfolio strategist, Doug Cliggott, also cut estimates, although he left his firm’s asset allocation at 60% in stocks, 20% in bonds and 20% in cash. A bullish albeit more balanced call.

Despite a slight drop in June, mutual-fund investors still have more money in stocks than they do in bond and money-market funds (both taxable and tax-free) combined. According to the latest reading from the Investment Company Institute, over 53% of the total assets in mutual funds are invested in stocks.

You don’t have to look very far back to see that such faith hasn’t always been rewarded. Back in 1950, only 16% of pension-fund assets were held in stocks, vs. 75% in bonds and the balance in cash. But as the Dow rose, so did stock-market investments, climbing to 75% of pension-fund assets in late 1972 — just as stocks began one of the worst bear markets in history. The current asset allocation for Calpers, the country’s largest pension fund, isn’t much different. According to its most recent release, Calpers holds roughly 63% of its assets in equities, with only 29% in bonds (the “target” allocation for bonds is actually lower at 28%). Egad! We can only hope the state of California will manage its pension plan better than its energy plan.

When I review prospective clients’ portfolios, I’m always most surprised not by what they’ve bought, but what they haven’t: bonds. They’ve all got the usual suspects: Cisco, General Electric (GE), perhaps some growth or international mutual funds. But when it comes to bonds, the cupboard is bare. Many are eager to discuss earnings announcements or the Nasdaq’s latest move. But ask them about interest rates and their enthusiasm doesn’t just wane, it dies altogether.

“Bonds are boring…nobody ever makes any real money in bonds,” they tell me. Say what? Tell that to holders of the Parnassus Fixed Income fund (PRFIX), up over 10% year-to-date, or to those fortunate enough to own BlackRock International Bond fund (CIFIX), up almost 11% over the last 12 months. Even as the bond market has outperformed stocks soundly over the past few months, public interest (read: investment) in bonds remains tepid at best. Search the Yahoo! message boards for “stocks” and you’ll find almost 40,000 posts, but a similar query for “bonds” revealed just 3,000 mentions.

Indeed, for most investors, coupons are still something clipped from the local newspaper. Maturity is what’s lacking in their younger siblings and yield means waiting for pedestrians at a cross walk.

And these days, there’s growing consensus, even among experienced professionals, that interest rates have bottomed. Yields, now near long-time historical lows, are bound to start ticking up soon, sending bond portfolios down. Think so? Time to check your premises!

In 1996, the S&P 500 posted a blistering return of 22%, and I can distinctly remember feeling as if 6400 on the Dow was as high as it could ever go. Trees don’t grow to the moon, I told myself — better lighten up and prepare for the inevitable drop. BusinessWeek, like many publications, was equally cautious, telling readers of its “Where to Invest in 1997″ issue that “stock market returns in 1997 will be far below those recorded during the past two years. Investors should expect a more modest 10% total return.” Of course, we were all completely wrong: The S&P went on to gain 33% in 1997, 28% in 1998 and 20% in 1999. While I can’t speak for BusinessWeek, I’ve long since learned my lesson. Trends, both in the market and in life, tend to persist, often longer than anyone believes they will. So forget the Fed. Forget the employment data, inflation or the dollar. Forget earnings, Abby Joseph Cohen and the broker urging you to hang in for “the long haul.”

Sure, the stock market has historically been the best-performing asset class, but I’m simply not content to twiddle my thumbs and wait patiently to see if history repeats itself. The fact is bonds have been strong. Strong securities tend to get stronger, while weak securities tend to become weaker. So while the world is waiting to call the bottom in the Nasdaq, I’m putting new money to work in the still-strong bond market.

Stock investors are essentially betting on the come. They’re assuming that the Fed’s interest rate cuts will stimulate the economy, revitalize earnings and send the market’s innumerable fallen angels back to their lofty highs. Meanwhile, bonds continue to march higher, leaving most investors standing at the proverbial plate.

I listen to the market, not to the analysts. And while you’ve seen terrific performance from the bond market in recent months, most people are still dogmatically convinced that the stock market will be higher in 10 years. Why? Because that’s the way it has always been. In my book, that isn’t just a leap of faith…it’s a death wish.

All around me, in short, I see it taken as an article of faith that large-cap stocks will move higher, and that bond prices will fall. And until that credo is abandoned, your best bet on a total-return basis might be in bonds.

– Originally on Aug 02, 2001 by Jonathan Hoenig