It’s not that the “great rotation” isn’t happening; it’s just that it’s not happening as most investors expected. That’s the idea put forth by Sanford Bernstein analyst Luke Montgomery, one he says will result in a lot disappointment for those expecting a boost in equity prices as a result.
The great rotation, a term almost as ubiquitous as the “New Normal” in the years since the economic crisis and rebound, describes the exit from bonds as yields scrape bottom and interest rate risk rises.
“A rotation mental model may stem from incomplete notions of supply, demand, pricing and flows in capital markets,” Luke Montgomery, an analyst at the New York-based firm covering asset managers, wrote Friday in a note to clients.
Montgomery cited “misconceptions over what happens when one investment type appears to win favor at the expense of another, saying there’s no automatic correlation between the migration of money and asset prices,” according to Bloomberg, who received a copy of the report. He also disputed the notion that individual investors are holding less in stocks than they have historically, supposedly setting up a major shift.
In the report, Montgomery questioned how much of a rotation can occur and what its impact would be. According to the news service, “he took aim at the argument that high levels of bank deposits and bond mutual fund assets created by the U.S. Federal Reserve’s stimulus efforts might suddenly pour into stocks.
“While quantitative easing floods investors with liquid financial assets and can inflate other asset values, this does not mean deposits in aggregate then become a latent source of funds for risk assets,” Montgomery wrote.
What’s more, he said, bonds can drop in value without money flowing into other assets.
“Wealth destruction in bonds can be an independent event — bond wealth can simply evaporate and need not be offset by wealth created in equities, or any other asset class,” he added, according to Bloomberg. “Once the rate hike cycle begins, there is a far wider range of possibilities for the future market values of (and allocations to) cash, bonds and equities than may be envisioned by the great rotation mental model.”
Money managers and related industry experts have debated the timing and severity of the great rotation since the term was first introduced by Bank of America Merrill Lynch analysts in 2011.
“The great rotation is a ridiculous notion. It’s utterly illogical,” DoubleLine’s Jeffrey Gundlach said in April. “You could also call it a great rotation into bonds from stocks.”
More recently, however, TrimTabs Investment Research said indicators were “very strong” the great rotation has begun, citing U.S. equity mutual funds and exchange-traded funds received a record $40.3 billion in July, easily surpassing the previous record of $34.6 billion in February 2000.
“We're really only a few months of these heavy flows, but yes, the ‘great rotation’ so many pundits have been expecting may finally be starting,” David Santschi, TrimTabs CEO, told ThinkAdvisor over the summer. “In June and July, U.S. equity funds posted an inflow of $39.9 billion, while bond funds redeemed $90.1 billion.”
Check out DoubleLine’s Gundlach Crushes Notion of Great Rotation, Bond Bubble on ThinkAdvisor.