Bernstein Says ‘Great Rotation’ of Bonds to Stocks Flawed
The idea of a “great rotation” from bonds to stocks is flawed and investors expecting that shift to boost equity prices may be disappointed, according to Sanford C. Bernstein & Co.
“A rotation mental model may stem from incomplete notions of supply, demand, pricing and flows in capital markets,” Luke Montgomery, an analyst at the New York-based firm covering asset managers, wrote today in a note to clients.
Montgomery cited misconceptions over what happens when one investment type appears to win favor at the expense of another, saying there’s no automatic correlation between the migration of money and asset prices. He also disputed the notion that individual investors are holding less in stocks than they have historically, supposedly setting up a major shift.
Investment analysts have been debating whether a major move from bonds to stocks, coined the great rotation by Bank of America Merrill Lynch analysts in a January 2011 research report, is under way. Michael Hartnett, BofA Merrill Lynch’s chief investment strategist in New York, wrote in an Aug. 15 note that the thesis has moved from controversial to consensus, joining analysts from UBS AG and Credit Suisse Group AG in recommending investment approaches based on the idea. Strategists from HSBC Holdings Plc, Deutsche Bank AG and Jupiter Investment Management Plc. disputed the rotation.
In today’s report, Montgomery questioned how much of a rotation can occur and what its impact would be. He took aim at the argument that high levels of bank deposits and bond mutual fund assets created by the U.S. Federal Reserve’s stimulus efforts might suddenly pour into stocks.
“While quantitative easing floods investors with liquid financial assets and can inflate other asset values, this does not mean deposits in aggregate then become a latent source of funds for risk assets,” Montgomery wrote.
What’s more, he said, bonds can drop in value without money flowing into other assets.
“Wealth destruction in bonds can be an independent event - - bond wealth can simply evaporate and need not be offset by wealth created in equities, or any other asset class,” he wrote. “Once the rate hike cycle begins, there is a far wider range of possibilities for the future market values of (and allocations to) cash, bonds, and equities than may be envisioned by the great rotation mental model.”
U.S. investors pulled $165 billion from equity mutual funds in the three years ended Sept. 30, according to data compiled by the Investment Company Institute in Washington. The Standard & Poor’s 500 Index of U.S. stocks, which lost more than half its value in the 2007-2009 financial crisis, rose 57 percent in the three years through September.
U.S. households, whom some expect to lead the shift into stocks, are already “modestly overweight” in equity holdings compared with their average position since 1951, Montgomery said. Pension funds are “sharply overweight” in stocks, he wrote.
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