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Why Talk of a ‘Great Rotation’ May Be Overblown

Thursday, 31 Jan 2013 | 10:48 PM ET
The Great Rotation
Stephen Davies, CEO, Javelin Wealth Management says talk of a great rotation out of bonds into equities has been overdone. He expects non-farm payroll numbers to show the U.S. economy is ticking over but not growing excessively.

Talk of a "Great Rotation" into equities from bonds this year as risk appetite returns is overblown, say analysts, adding that a big shift in market positioning is unlikely to come until stronger signs emerge that the global economy has turned a corner.

The theme has been gaining ground as investors pile back into stocks: the S&P 500 posted its best January performance since 1997, while shares in Europe and Asia hit multi-month highs this week.

That move has coincided with a sell off in safe-haven bonds, with yields on benchmark 10-year Treasurys edging above 2 percent this week for the first time since early 2012.

The "Great Rotation" implies that long-term investors such as pension or insurance funds are starting to make a shift back into equities from holding heavy positions in the bond market where yields have fallen more than 250 basis points in the past five years as caution and fear prevailed following the global financial crisis.

(Read More: The Great Rotation: A Flight to Equities in 2013)

While confidence is returning to global markets, a "Great Rotation" into equities from bonds will only really get underway when the economic rebound in the U.S. becomes more pronounced and unemployment falls significantly, said Javelin Wealth Management CEO Stephen Davies.

"I think talk about the 'Great Rotation' has been massively overdone. I don't think we're going to see a massive switch out of fixed income into equities over the course of the year," Davies told CNBC Asia's "Squawk Box."

Key U.S. non-farm payrolls data due later on Friday may serve as a reminder that employment conditions in the world's biggest economy remain weak. The U.S. Federal Reserve has said its ultra-lose monetary policy will stay in place until unemployment falls below 6.5 percent.

Economists expect Friday's data to show the unemployment rate stayed unchanged in January at 7.8 percent.

Data earlier this week meanwhile showed the U.S. economy shrank 0.1 percent in the fourth quarter of last year, defying expectations for slow growth.

(Read More: Market Braces for a Blah Jobs Report as Firms Hold Back)

"Yes, we have seen a little bit of it (a rotation into stocks) because it's a reflection of yields that are at relatively low levels, so where else are you going to go?" said Davies.

Tim Condon, head of research for Asia at ING Financial Markets in Singapore, says he expects a gradual trickle of funds into stocks from fixed income markets.

"Maybe it's not a flood but there is a trickle of funds out of fixed income into equities. We've had 5 years of huge gains in fixed income and that is over," he said adding that ING forecasts the yield on 10-year Treasurys to creep up to 2.2 percent by the end of the year.

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Art Cashin, director of floor operations at UBS Financial Services, told CNBC earlier this week that the "Great Rotation" is something he is increasingly being asked about.

"The big question is: are we going to see a big rally out of bonds into stocks? If so, not only is the (stocks) rally for real, it's also likely to have a long life behind it," he said.

Indeed, amid the growing optimism about the global economy, mutual funds are starting to see net inflows. According to Lipper, U.S. mutual funds have seen four consecutive weeks of net inflows, taking their four-week total to $20.7 billion, the biggest four-week total since the period ended April 12, 2000.

"The big story coming for the year is going to be sector rotation, a lot of money coming out of bonds," said Ed Ponsi, Managing Director at Barchetta Capital Management.

"In the U.S. especially, Treasurys are breaking key support levels. Now some of that money is going into U.S. stocks and some of the money is going into European stocks and that's part of what's fueling the rally in the euro right now," he added.

(Read More: This Euro Rally Could Keep Going for a While)

ING's Condon says the significant change is not the flow of money from bonds to stocks but the shift in perception towards stocks that have taken a beating in recent years.

"So there hasn't been a massive shift in funds flows but there has been a shift in mindset towards an asset class that many people had written off," Condon said, referring to a comment made last year by Bill Gross, co-chief investment officer at bond fund Pimco, that the "cult of equities" is dying. "Many people are re-assessing this view," Condon added.

- By CNBC's Dhara Ranasinghe; Follow her on Twitter: @DharaCNBC

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