By Michael Santoli
Don’t get too excited by the recent hoopla about a “Great Rotation” of investments from bonds into stocks, a momentous shift in asset preferences that’s said by many market commentators to be underway in 2013.
But a quieter migration from low-yielding cash and low-volatility hedge funds toward stocks is quite likely, and could usher in the “exuberance stage” of the equity bull market that typically carries indexes to higher highs before the bull expires.
So says Liz Ann Sonders, chief investment strategist at Charles Schwab, which oversees nearly $2 trillion in assets for retail investors. Referring to the $20 billion in net inflows to stock funds last month after years of withdrawals, Sonders notes in the attached video that “January is always a strong month for fund flows. It’s a little bit too soon to say the Great Rotation has begun.” Indeed, bond funds collected fresh money as well, with most of the cash heading toward stocks and bonds coming from money market funds.
Because money market funds yield essentially nothing – and less than nothing after inflation – this pattern of cash moving into return-seeking asset categories should persist. “I just don’t think we’re yet at the point when we’re going to see the biggest funding of equity buying coming from bonds,” she says.
Historically, such a shift requires both the pull of better stock appreciation and the push of higher bond yields, which drive outright losses in bond investments. We’re not there yet, given still-strong credit markets.
It’s worth asking how much of a lift a flood of new public capital into stocks would produce, given that the major equity indexes are up 120% from their March 2009 lows even without enjoying the benefit of retail buying.
Sonders adds that it hasn’t only been the little guy sitting out the stock rally. Pension funds and endowments are running with record-low equity allocations, as they have tilted toward bonds and “alternative investments,” a category that includes private equity, venture capital and hedge funds. Hedge-fund returns have lagged those of straight equity indexes for the past three- and five-year periods, Sonders says, raising the possibility that institutions and wealthy investors might soon reposition from these hedged products back toward stocks.
If macroeconomic and policy risks remain in abeyance, a rediscovery of stocks could generate what market strategist Laszlo Birinyi of Birinyi Associates calls the “exuberance” phase of a bull market, in which the majority of investors finally concludes that it’s safe to jump in and chase prices higher. Such a phase follows the reluctance, consolidation and acceptance stages - with reluctance and exuberance historically producing the greatest upside of a bull cycle.
Citing this rubric, Sonders says, “I do think we have the opportunity for some pretty good rallies here,” even if “most of the collective gains we’ve probably already seen.”
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