The Great Rotation : A Trap

There is an idea, the “Great Rotation”, that we hear a lot about since the beginning of the year, a great underlying movement that should be happening in the markets: investors moving from bonds to stocks.

In order to understand this movement, we have to go back a few years. The stock market went through two major crashes, one in 2000 (mainly tech stocks) and the other in 2008 (subprime crisis). At the same time, the sovereign bonds of the major countries (USA, Germany, UK, emerging countries) were doing well, and lower and lower rates made for substantial gains for bond holders. As a consequence, bonds are overweighed in investors’ portfolios with regard to stocks.

Now that interest rates are at their lowest and are even starting to rise, and that the economy seems to be gaining some traction, if we are to believe the leaders of the United States and Europe, we should be witnessing a re-balancing of portfolios in favor of stocks, an outflow of capital from sovereign bonds toward the stock market, thus sustaining growth, along with a reduction of budgetary deficit and less stress on the bond market… In any case, such is the daydreaming of our monetary and political leaders.

But, what of it, really? There is no recovery, as we’ve mentioned here before, Europe is stagnating and the United States is still below 2% growth, despite an abyssal budgetary deficit and $85B of quantitative easing each month. But it would seem the “Great Rotation” is under way!

According to Thomson Reuters Lipper, investors have withdrawn $3.27B from U.S. Treasuries in the first seven days of August, the highest amount ever recorded since 1992, while, at the same time, $6.28B were invested in stock market funds. This movement is also taking place in Europe, especially in the South, to the point where the bourses of Milan and Madrid are progressing by 8% monthly, three percentage points higher than London or Paris, and six points more than the S&P 500! And these two countries are in a recession!

It looks like the “Great Rotation” is underway, but for the wrong reasons: shying away from bonds because of rising rates, and a return on the stock market due to an illusory recovery, and the belief that the eurozone crisis is over…  Many will be cruelly deceived when the last hopes of economic recovery will definitely vanish and everybody realizes that they have grossly overpaid their stock shares. For example, the Norwegian sovereign fund has indicated that, as of the end of June, its investments in the stock market stand at 63.4% of its total investments, a record, and its investments in bonds have fallen to 35.7%. This kind of risk taking might be qualified as exorbitant.

So, when will we see a “Great Rotation” toward gold or, more generally, toward real assets, which would be more reasonable? We will surely have to wait for another crash before the bankers understand…