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July 29, 2016

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Michael Sonnenfeldt doesn’t mince words: “There is no safety in safety,” thefounder of TIGER 21, a network of”ultra-high-net-worth” investors, said. “All of the historical places you could get safe income from-dividend-paying stocks, bonds-they’ve all beenbid up because of quantitative easingto the point where it’s just trash.”Assets that includeTreasury notes, high-quality dividend stocks, and low-volatility mutual funds have all seen spooked investors rush into their supposedly safe embrace. Sonnenfeldt and others argue that has transformed them.

“When you overpay for what used to be safe assets,” he said, “they now have a lot of risk in them.”

Whether they’re “trash” is debatable. But the concern that the prices of these assets may now be propped up more by fear than by economic fundamentals is legitimate.

Here’salook athow some “safe” assets that investorshave raced into over the past year or soare holding up. Fora backdrop, take a look athow the S&P 500 has performedsince last August’s deep dive.

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August’s turmoil was followed by more market mayhem in early 2016, and then Brexit struck. From August 24, 2015, when the Dow plunged some 1,000 points before closing with a 588-point loss, the blue-chip index is up 16.9 percent and the S&P 14.6 percent. Even if you look at the indexes from before the big drop-from, say, July 31, 2015, to July 28 of this year-the Dow is up 4.3 percent and the S&P 3.4 percent.

Within the S&P 500, low interest rates have madedividend stocks hotly sought-after for income. Vanguard’s Dividend Growth Fund (VDIGX) has almost doubled in size in three years, to $30.6 billion, $3 billion of which flowed in over the past six months. To protect the fund’s long-term returns,Vanguardannounced on Aug. 27 it wasclosing VDIGXto new investors.The fund has beaten 83 percent of itspeers in 2016 and 86 percent over five years, according to data compiled by Bloomberg. It tracks the overall priceperformance of theS&P 500 pretty closely. But it has atotal return forthe past 12 months of 7.2 percent, compared with the S&P’s 5.4 percent.

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The top three holdings in the dividend fund, making up 9.4 percent of assets, are Microsoft Corp. (MSFT), Costco Wholesale Corp. (COST), and United Parcel Service Inc. (UPS). The trio has had a good 12-month run. Microsoft has gained20.4 percent, Costco is up 14.5 percent, and UPS is up 6.2percent.

In Treasury notes we trust

The 10-year Treasury note is seen asa haven in a world where negative interest rates on sovereign debt are becoming more common. Last August, the 10-year Treasury yielded 2.2 percent. Since then, its popularity has driven its price up and sent its yield down to 1.5 percent. The current dividend yield on the S&P 500: 2.1 percent.

“Historically people looked for debt to produce income and for the equity market to produce gains,” said Tiger 21’s Sonnenfeldt. “Now people look to the stock market for dividends and to the debt market for gains, because you won’t get any income there.”

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That price may have farther to go. “If peopleget scared enough, they will rotate into Treasuries this time, too,” said Sam Stovall, U.S. equity strategist for S&P Global Market Intelligence. And that wouldn’t bewise, he said.

He noted that on July 11, the S&P 500 reached breakeven aftera drawn-out correction from late May in 2015 to mid-February of 2016 that whittled 14 percent off its value. The stock market tends to get a second wind when it gets to breakeven, he said, and no bull market that lasted longer than three years has posted a final-year advance of less than 15 percent.

“We may see a good year eight, and maybe a year nine, in this bull market,” Stovall figures. “Bull markets don’t end when a lot of people are cautious. They end when everyone is fully invested and there is no money to propel it further.”

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The lure of low-vol funds

The promise of low-volatility funds is a return that is slightly lower than the broad stock market, in return for a smoother ride. Funds with low-volatility strategies haveseen money flood in.The iShares Edge MSCI Min Vol USA fund (USMV), the biggest ETF of the group, is the king of the hill, with more than $15 billion in assets, up from $5 billion a year ago.

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“Until this year, low-volatility ETFs took in a steady clip of cash from true low-vol seekers,” said Eric Balchunas, exchange-traded-fund analyst for Bloomberg Intelligence. “But when the ETFs began outperforming, more hot money started piling in.”

Balchunas isphilosophical about the melt-up. “Everyone knows performance-chasing usually ends badly, but people do it anyway,” he said. “It’s part of human nature.”