The great migration from bonds into stocks that many market strategists have been forecasting for 2017 is equivalent to the “fake news” that spread during the presidential campaign, according to Goldman Sachs strategists.
“The political rotation occurring in Washington, D.C….[which] has prompted investors to focus on prospective tax and regulatory reforms after years of partisan gridlock … will not be mirrored in financial portfolios,” write Goldman strategists in their weekly “Kickstart” report. “Despite the sharp fall in bond values during the past six months and the prospect of further losses in 2017, we expect minimal asset rotation away from debt.”
Goldman strategists explain that many categories of investors are restricted from allocating assets away from bonds because of regulatory and policy constraints and investors that have the ability to shift assets, such as pension funds and households, are currently holding extremely low levels of debt – the lowest in 30 years.
Among those investors who face restrictions in shifting assets are the Federal Reserve, which owns $4.2 trillion worth of Treasury and agency debt but no municipal or corporate bonds, and insurance companies, which own $3.2 trillion worth of corporate bonds. The Fed is not allowed to own equities and insurance companies operate under risk-based capital guidelines that “impose a high cost to own equities,” according to the Goldman strategists.
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Even mutual funds, which “may” move assets from bonds to stocks are expected to do so in a limited fashion, according to Goldman. Mutual funds, pension funds and households (a category that includes endowments, U.S. hedge funds and endowments) combined own $13 trillion worth of bonds, or roughly one-third of the $41 trillion domestic bond market.
These investors stand to lose hundreds of billions of dollars in their bond portfolios as rates rise. If the yield on the 10-year Treasury note rises to 3% by year-end, as Goldman economists are forecasting, those investors could lose approximately $500 billion in aggregate, or 4% of the value of their debt holdings, according to Goldman.
If yields increase an additional 40 basis points, with the 10-year Treasury at 3.4%, they stand to lose $850 billion in their bond holdings, representing a 6% decline in market value.
(Related: Bob Doll’s 10 Predictions for 2017)