WSJournal. Once More, Awaiting a 'Great Rotation'
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WSJournal. Once More, Awaiting a 'Great Rotation'
Signs Indicate Investors Are Starting a Long-Awaited Move Out of Bonds and Into Stocks, But Skeptics Remain
As 2013 gets under way, one of the biggest questions in financial markets is again bubbling: Will this finally be the year that investors dump bonds and return to stocks?
For years, market watchers have called for what has become known as the "great rotation" out of bonds and into stocks. And for years they have been wrong.
Now, some signs are indicating that maybe, possibly, the tide is beginning to reverse.
Stocks started 2013 with a bang. For the week ended Wednesday, U.S. investors plowed $18 billion into stock mutual funds and exchange-traded funds, the largest one-week total since June 2008, before the worst of the financial crisis hit.
"That caught people's attention," says Matthew Lemieux, senior research analyst at Lipper.
That followed a growing exodus from U.S. Treasury funds. Since late June, investors have pulled $6 billion from the group, including $1.1 billion in the week ending Wednesday.
The moves run counter to a trend that began in 2008, with investors since then pulling money out of stocks and putting $1.1 trillion into taxable government, international and corporate bonds.
Fueling expectations that a longer-term shift out of bonds and into stocks may finally take place is a growing nervousness that bond yields are dangerously low. As 2012 drew to a close, U.S. Treasury yields weren't far from record lows thanks to the Federal Reserve's unprecedented effort to pump money into the financial system through bond purchases. That sent prices up, and yields down.
But, due to a quirk of bond math, losses are exaggerated when yields are low. That risk has been brought into sharp relief since the start of 2013. In just three trading days, long-term Treasurys lost 3.07% in value, more than wiping out the 3% coupon payment they will deliver in 2013, according to Barclays BARC.LN +0.14% .
On Jan. 4, the yield on the benchmark 10-year Treasury rose to 1.914%, an eight-month high. Some worry it could quickly rise above 2.25%, which would cause sizable losses. The 10-year Treasury yielded 1.871% as of late Friday, up from 1.759% at the end of the year.
Meanwhile, yields on both investment grade and riskier junk bonds hit record lows last week. Against this backdrop, many observers are saying it is only a matter of time before investors seek out stocks. They note that shares of dividend-paying companies are often providing higher yields than the company's bonds. With high-quality bonds offering yields below that of the rate of inflation, many investors worry that they aren't being compensated enough for the risks of holding them.
"I think the 'great rotation' has already started in terms of flows and returns," says Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch.
Mr. Hartnett is watching for three indicators to determine whether the shift will continue: a falling unemployment rate, a continued drop in returns from fixed-income investments, and a growing belief among investors that the Federal Reserve may end its bond-buying program. These factors could all make Treasurys seem much less attractive.
"Now all we are waiting to see is collaboration from both the economy and policy makers," Mr. Hartnett says.
Other Wall Street firms have also taken note. In a report titled "The Search for Yield—Equity Opportunities," released early this month, Goldman Sachs GS -0.17% analysts made the case for buying dividend stocks instead of bonds.
Corporate America, Goldman argues, is flush with cash and pays a dividend yield of 2.2%, compared with a 1.6% yield for the average triple-A rated company bond.
Goldman noted that investors in Treasury and investment-grade corporate bonds stand to lose a lot of money should interest rates ratchet higher. With rates at such low levels, it wouldn't take much of a move to cause losses, analysts say.
Analysts on average expect 10-year Treasury yields to rise to 2.15%. That would indicate a 2.5% drop in price. If yields moved up to 2.5%, which some say is possible, the price of the bond would fall by 5.5%. Many investors in Treasurys and investment-grade corporate bonds say they are closely eyeing 2.25% as a threshold that may trigger selling.
Last week's eye-catching $18 billion move into stock funds included $9 billion heading into U.S. stock mutual funds, the largest take since September. More notably, traditional mutual funds—in other words, not ETFs—attracted $4 billion in just the one week, the first positive week for the group since mid-July.
However, things get a bit murkier from there. That one-week shift into U.S. stocks is just a drop in the bucket compared with the $44 billion that drained out in the previous 24 weeks.
In addition, overall, bond funds continued their record-shattering haul. During the week ended last Wednesday, bond mutual funds and ETFs attracted $4.2 billion, Lipper says.
And market observers, including Mr. Lemieux of Lipper, say unusual factors were at work late last year. Many investors stepped to the sidelines late last year as they worried about the year-end budget debate in Washington and its possible effect on the economy. Once that was resolved, they likely moved back into stocks in January.
At the same time, the last four years have started off with investors shifting money into U.S. stocks only to see that trend reverse in each of those years.
Many market watchers also note that continued wrangling in Washington, particularly over whether to raise the country's borrowing limit, could make some investors leery of moving out of Treasurys, seen as a haven in times of turmoil, and into stocks.
"The debt-ceiling debate is still out there," says John Bender, head of U.S. fixed income at Legal & General LGEN.LN -0.53% Investment Management America. He says that will keep Treasurys strong for the first quarter of the year.
And most analysts say that even if investors do continue to lighten up on Treasurys, and possibly investment-grade bonds, 2013 probably won't see a flood of money leaving those funds.
Still, many fund managers say they are paying close attention.
"This year could be somewhat a transition year," says Dan Heckman, senior fixed-income strategist at U.S. Bank Wealth Management, which oversees $110 billion in assets.
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