The asset allocation tides should not be ignored when considering why investors remain overwhelmingly in favor of bonds over equities according to Mark Tinker, a global portfolio manager at Axa Framlington.
"In our approach to markets we talk a lot about headwinds and tailwinds, particularly to do with stocks and themes, but we do not ignore the underlying asset allocation tides,” Tinker wrote in notes sent to CNBC Wednesday.
“For now, they remain against equities and in favor of bonds, as fear of being in equities combines with fear of being out of bonds," he said. "In truth, however hard the earnings winds blow, equities can not go into a bull market without the help of the asset allocation tide away from so called risk-free assets.”
TheS&P 500 index has been trading in a tight bandfor over a year is being dragged up and down within that band by solid news during earnings season and negative news from the apocalyptic visions of some of the macro boys, Tinker said.
“It matters for little what we says about profitability, the emergence of China or the true nature of the global financial crisis, the marginal buyer is someone who believes that the US nonfarm payrolls are all that matters, that the world can not grow without the US consumer and that the equity rally from the 2009 lows was the anomaly rather than the fall that preceded it,” he said.
“This is a world that sees no risk in bonds, but plenty in equities, rather as the new economy saw no use for the old in 2000,” he added.
Bonds Prices Not Predictive
“The bull market in bonds is leading asset allocators to ascribe ex-post rationalization to the predictive power of bond markets," Tinker said. "Thus the market is apparently predicting deflation and equities must fall accordingly. Except it isn’t, it is going up because $480 billion has moved into bond-related mutual funds over the last two years.”
“These flows are largely coming out of money-market funds, where the return is all but zero," he said. "It is also going up because risk managers are forcing long term-allocations into 'risk free' asset classes. It is going up because the (Federal Reserve) will lend banks money very cheaply to buy bonds at the same time as apparently promising to buy those same bonds back at a higher price in the name of (Quantitative Easing). It is not going up because it has any insight into the prospects for growth and inflation.”
The commodity market experienced a similar experience in 2007-8, as analysts talked up the fundamentals as oil was pushed to $147 a barrelwhen, in fact, it was leverage and the emergence of ETFs and mutual funds chasing the momentum trade for the best part of five years, he said.
“The trigger for the collapse seemed to be a simple running out of momentum that then triggered the leveraged unwind,” Tinker added.
Trend Is Still the Friend
Stocks will continue to struggle with the asset allocation tide, Tinker said.
“What will change (the trend)? We suspect it will be the US announcing a different sort of stimulus and an end to QE2," he said. "Any selloff in bonds that is not backstopped by the Fed would lead to an acceleration as the leveraged players on the yield curve dash for the exit.”
“The so-called fundamental that seemed to slow the momentum into commodities in 2008, was the belief that economies were going to slow rapidly," he said. "This undermined the 'story' being used to attract new players into the game; that economic growth was going to keep booming. The equivalent in bonds is that the Fed is going to provide both the lender and the buyer of last resort.”
As a result, Tinker said he believes there is a bond bubble due to a combination of forced buyers, momentum players and a lot of leverage.
“We have another month ahead of us of macro noise before the earnings season brings bottom-up reality back to equities," he said. "The most crowded trade is on the sidelines and that looks likely to remain the case for a while yet. Ultimately, the beta of the equity market is still in the hands of other asset classes.”