By Jeffrey Rosenberg
The “Great Rotation” story began with the devastating impact of September 2008 and roughly 40% decline in equity portfolios for the year. Measured since 2007, bonds have seen a cumulative inflow of nearly $1trn while developed market equities have seen roughly $400bn of outflows (and $460bn of outflows when measured from 2008).
Missing from this discussion, however, is the “other” great rotation. In the panic following the 2008 collapse, investors initially flocked to cash. Money fund assets provide one measure for tracking the amount of cash in investor portfolios.
Near the end of 2012, the trend towards reduced cash holdings reversed abruptly due to the post-election fiscal cliff-induced uncertainty. Investors increased their cash holdings to the tune of $150bn in money market funds and another $200bn in deposits over November and December. For money funds, this return completely reversed the year–to-date outflow from money funds witnessed through the end of October. With these flows in money funds and deposits as background.
Rather than a rotation between these two asset classes, stocks appear to benefit from a rotation out of cash as money fund holdings have declined by $21bn from their peak in January while commercial bank deposits have declined by $141bn.
Presumptive in the “rotation” view is a stock market rise fueled by a return of asset allocation flows into equities missing since the onset of the 2008 credit crisis. Unfortunately the flows follow the returns. January’s negative bond returns coupled with strongly positive returns for stocks suggests that if sustained such “Great Rotation” may eventually show up.
Flow trends in January reflected movements into stocks from cash, while allocations to bonds actually increased, hardly indicative of the “Great Rotation”. And consider an entirely different “rotation” possibility: having now recovered stock market losses from the 2008 crisis, rising equity prices lead these investors to sell their equities as they look to lock in their gains and de-risk their portfolios in retirement. The flows haven’t followed the returns in recent years to equities as fixed income returns have kept pace. But as January’s returns highlight, and as our forecast for only 1-2% returns in 2013 suggest, this year may begin to shift that calculation as returns to fixed income lag those of equities leading to eventual realisation of such a rotation from bonds to equities.
The concern implicit in the “Great Rotation” theme lies in the manner of the move: a gradual smooth transition likely leads to little market dislocation while an abrupt move, exacerbated by a lower degree of fixed income market liquidity in a post-crisis, post-regulatory reform fixed income marketplace, leads to heightened market volatility and the potential for even greater market dislocation.
Our advice remains to prepare the fixed income portfolio for the prospect of gradually rising interest rates in 2013: reduce interest rate risk through lowering duration exposure, making up for lost yield in select areas of credit risk-exposed fixed income sectors.
Even in that latter recommendation we further recommend overall diversified exposures and tactically this month we pare back high yield.
Jeffrey Rosenberg is chief investment strategist for fixed income at Blackrock
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