The Great Rotation

Cash flowed into the US stock market at a pretty fast clip last week with Lipper reporting that US stock funds received $9 billion in new allocations. Bond funds didn’t miss out entirely though with $4.2 billion of inflows. If we just looked at the Stock flow we’d say the market is bullish. If we just looked at the bond flow we’d say the market is still concerned about stocks. Taken together though we think this means cash which had been on the sidelines is being redeployed as fear recedes and as Bernanke’s zero rates and unconventional monetary policy is working and forcing people into the markets and out of safe havens.

In a not unrelated sign and possibly the best sign that the euro rally may have some legs and underlying support the Swiss Franc slipped to the lowest level in a year with EURCHF rising to 1.2201 the strongest since Dec 2011. The change in euro sentiment was nicely summarised by a quote I saw on the Wall Street Journal this morning:

“PEOPLE WERE OVERLY FEARFUL OF THE EURO ZONE, AND NOW THIS FEAR IS STEADILY RECEDING,” WHICH HAS LED TO A DROP IN THE SWISS FRANC, SAID SEBASTIEN GALY, A CURRENCY STRATEGIST AT SOCIÉTÉ GÉNÉRALE IN NEW YORK.

The WSJ also reported a UBS note which said that  Swiss investors who had been repatriating their cash for the past two years are now reversing those trades. As I have noted recently these moves don’t mean that Europe is out of the woods fundamentally but rather that the market views the chances of a European implosion and Grexit or Spexit as having reduced materially.

With the VIX Volatility index on the S&P500 at its lowest level since around 2007 it is clear that fear is receding across all markets. Indeed the fact that the Australian Dollar can’t benefit at the moment and is lagging the “risk” rally also suggests that perhaps money is flowing out of the safe harbour that has been the Aussie dollar and Australian assets.

Merril Lynch strategist Michael Hartnett is apparently calling the moves we have highlighted above, including soaring Junk Bond prices, as the “Great Rotation”. This may be slightly hyperbolic but it does summarise what is occurring nicely.

Indeed we saw that Esther George who is President of the Kansas City Fed (Hat Tip WSJ) had given a speech about this very topic.

A LONG PERIOD OF UNUSUALLY LOW INTEREST RATES IS CHANGING INVESTORS’ BEHAVIOR AND IS RESHAPING THE PRODUCTS AND THE ASSET MIX OF FINANCIAL INSTITUTIONS. INVESTORS OF ALL PROFILES ARE DRIVEN TO REACH FOR YIELD, WHICH CAN CREATE FINANCIAL DISTORTIONS IF RISK IS MASKED OR IMPERFECTLY MEASURED, AND CAN ENCOURAGE RISKS TO CONCENTRATE IN UNEXPECTED CORNERS OF THE ECONOMY AND FINANCIAL SYSTEM. COMPANIES AND FINANCIAL INSTITUTIONS, SUCH AS INSURANCE COMPANIES AND PENSION FUNDS, AND INDIVIDUAL SAVERS WHO TRADITIONALLY INVEST IN LONG-TERM SAFE ASSETS, ARE FACING CHALLENGES EARNING REASONABLE RETURNS, AND SO THEY MAY REACH FOR YIELD BY TAKING ON MORE RISK AND REALLOCATING RESOURCES TO EARN HIGHER RETURNS. THE PUSH TOWARD INCREASED RISK-TAKING IS THE INTENTION OF SUCH POLICY, BUT THE LONGER-TERM CONSEQUENCES ARE NOT WELL UNDERSTOOD.

Is the current stock market ebullience that sees US stocks just 5% below all time lows sustainable? Who knows – the economics of the US, Europe and Japan suggest it may not be. But then central banks aren’t going to give up until they get the economies of the US, Europe and beyond moving forward again with positive and sustainable growth and crucially with improved employment outlooks.

From a trading and investing perspective it is important to note that central banks will continue to man the monetary spigot but equally to note that each of the past few years has started off with hope and glory only to hit a mid year hiccup.

So while positivity is the new black the market and sentiment will continue to ebb and flow so we remain nimble and trade the market in front of us – not the rhetoric.

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Comments

  1. Possibly Spain, Italy. France as well. Portugal. And Greece. Only can kicks. Absolutely nothing resolved. Huge amount of debt that cannot be repaid.

    Amazing how quickly we start to think things are rosy.

    Last time EUR was this high it preceded another ramp-up in the crisis.

    • Are you serious? have you seen the falls in the bond rates? I think that the 3yr Italian bond rate fell below 2%

      • A falling EUR now will knee-cap any potential recovery. There is a danger that Draghi hot air will lift spirits (aka bond rates) prematurely. They are setting themselves up for the next part of the crisis.

        None of the massive debt burden that permeates the periphery states is resolved.

        So nothing whatsoever is resolved.

          • dumb_non_economist

            Us is recovering well; according to who? My rellies over there and HnH are in agreement, bugger all recovery!!

        • Not only the existing debt burden, the trade and current account deficits and the government deficits.

          Anybody got a summary of the changes in the Net International Investment Position of the PIIGS over the last 10 years?

  2. The US is recovering well?

    Are you talking about the USA? That country in North America? Surely, the last thing anyone would say about it is that its ‘recovering well’.

    The nightmare debt-ceiling scenario awaits, and the great economy is toying with trillion-dollar platinum coins!

    C’mon. The game is over.

    • Still living in 2009? a new decade commenced 3 years ago. 3% GDP growth is ABOVE trend.

      Stock market approaching all time highs, corporations holding massive cash reserves, unemployment slowly falling, housing market coming back strongly.

      Get yourself a calendar and treat yourself to a Google search. It’s free.

      • Deluded Much???

        Stock market approaching all time highs – courtesy of Ben Bernanke

        corporations holding massive cash reserves – lets see what earnings season brings I think its topped out

        unemployment slowly falling – nothing to do of course with the millions falling out of the numbers counted and into disability benefits

        housing market coming back strongly – courtesy of flippers and speculators. I believe there are hedge funds also allocating billions of $$$ to try and chase yields in the rental markets.

        I think its YOU who needs to do a google seach

        • I agree with Peter on this one.

          Here in the US Private Equity arena, portfolio companies (middle market) are performing to budget and operating with low leverage, which has either been paid down or offset by increasing cash balances. Costs were rationalised in 2008/9 and capex spending has been only maintenance since then. Companies are now beginning to spend on equipment and hire again (many were also waiting for the election to pass).

          Within the private debt markets, CLO’s and pension funds are back looking to invest in debt securities that provide yield, thus pushing down borrower costs of funding. On the hiring front, Banks are also competing with each other to hire analysts and associates. All the people I know that were made redundant since 2009 have since been reemployed.

          The situation is far from perfect, but by no means Armageddon, Americans love to spend and companies here have access to a super hardworking, cheap labour force of immigrant workers.

    • The debt ceiling will be just one more fizzer for the Republicans who are now more lowly regarded than many objectionables. Do a Google search on that as well.

      • You didn’t obviously read the link, otherwise you would have noticed that the usual suspects that you would trot out to support your recovery meme have downgraded their forecasts:

        “Goldman Sachs: 1.8% to 1.3%
        JPM: 1.5% to 0.8%
        RBS: 1.5% to 0.7%
        Nomura: 2% to 1.3%
        Last, and least, Deutche Bank’s Joe lavorgna: unchanged at 1.3%”

        The people who rally the hardest against ZH in my experience are the ones who rarely/never visit the site, because they can’t sort the wheat from the chaff i.e. get distracted by all the constitutional gun nuts over there or the steady stream of ‘return to the gold standard’ articles, and then diss the whole site.

        You will find Pete that the same stories are trotted out there as on MB e.g. dangers of housing bubbles and high levels of toxic private and public sector debt, unscrupulous actions of banks, the whole Euro debacle etc etc.

  3. ” But then central banks aren’t going to give up until they get the economies of the US, Europe and beyond moving forward again with positive and sustainable growth and crucially with improved employment outlooks.”

    Central Banks aren’t going to give up until they get the economies moving again with debt increasing at an exponential rate forever. In particular, China will continue forever, despite obvious demographic and prosperity factors, to produce cheap goods at low wages, and send them to the Western world in exchange for worthless bits of paper.

    Yes! Can’t see how their plan could possibly go wrong.

    Note the immediate deterioration in the USA external account in response to the pick-up in activity.
    NOTHING has been addressed.
    NOTHING has been solved.

    • Jumping jack flash

      “Central Banks aren’t going to give up until they get the economies moving again with debt increasing at an exponential rate forever.”

      +1

      Continuation of the delusion that we are all banks, and debt is magically an asset.

      Many believed the delusion to the point where they set up their own finance operations – it was the next logical step. Most notably GE, GM, Woolworths. A host of others, too.

  4. You might want to go to shadow stats to find out what the real numbers are Peter. It is all smoke and mirrors to promote confidence- they want credit to expand back to Pre 2008 levels, which will not happen. Everyone is deleveraging.

  5. Nonsense.

    Peter, the USA is in serious strife. The wheels of history turn very slowly, and it can be very difficult to see the changes happening before our very eyes when they are happening at a glacial rate and scope.

    The US is a modern imperial empire in decline. As far as its legacy goes, it has been un-remarkable (compared to the longevity of past empires).

    It is now the largest debtor entity in the history of all humanity. It is decaying internally and externally.

    Its culture is insular, predatory, parochial and mimics in its internal malaise the social and economic disintegration of the Roman empire, for instance.

    As for the ballooning pent-up ‘capital’ looking to find its exploitative release, yes, maybe thats true.

    And only justifies my argument further. Here’s what I found on ‘google’.

    http://www.counterpunch.org/2013/01/11/housing-bubble-on-the-horizon/

    History rhymes, as Paine used to say.

    • CounterPunch – that is an opinion on what may happen under the new lending regulations. I haven’t read their regulations so I can’t really comment.

      I don’t understand the US hang up with limits on servicing/income ratios as a “one size fit’s all” rule – one size doesn’t fit all, it just doesn’t work that way.

      I think that have a stronger clause that prevents lenders from lending to borrowers who haven’t been able to demonstrate an ability to repay, but until that is tested in court no one knows whether it has teeth, or whether it will be policed adequately, but we can only hope.

      Either way it is certainly not a done deal that the US will repeat their sins immediately.

    • +1 Nice phrasing

      “Its culture is insular, predatory, parochial and mimics in its internal malaise the social and economic disintegration of the Roman empire, for instance.”

  6. Ortega
    “The wheels of history turn very slowly, and it can be very difficult to see the changes happening before our very eyes when they are happening at a glacial rate and scope.”

    I’ve quoted this a few times here but it is a worthwhile addendum to your so very true statement.
    “If we’ve learned anything by running this site since 1998 it’s that even the most clearly foreseeable disaster in the making takes longer to arrive than the cruelest imagination can conceive.” Eric Janszen itulip.com
    For US investors Jansen’s macro analysis and recommendations have been pretty spot on all the way through

    Further I believe, in the Western world, we are close to the end of a 50 year cycle. It started with Japan’s industrial revolution providing the west with cheap goods. It ends with China. There is not another China.

    • Interesting how, as soon as Obama was re-elected, he rushed off to Burma in the hope that with its newly-liberalised economy it can be another mini-China for the global economy, and a shot in the arm for the USA.

      Also, look for the crippling 50+ year economic embargo to be lifted on Cuba sometime during Obamas new term. The Cuban exile community in Miami is ageing, and as we saw over the past election, its influence over US foreign policy is waning.

      Cuba has also passed majority votes condemning the embargo in the UN General Assembly for 20 years. Countries consistently voting with Cuba include Australia, UK, Canada, Japan, France, Russia, etc. etc.

    • Flawse & Ortega

      Do you subscribe to K-waves? (genuine query). I’d be interested to know what other MB commentators think about this, given it is deemed ‘non-orthodox’.

      In principle, I don’t see why if economists posit the existence of short term business cycles, that they wouldn’t believe there would be longer term underlying cyclical behaviour in the economic system.

      Further, if we have learnt anything from science, it is that cycles/patterns/phenomena repeat often at both the micro and macro scale.

      Personally, I haven’t made my mind up yet…

      https://en.wikipedia.org/wiki/Kondratiev_wave

      “In economics, Kondratiev waves (also called supercycles, great surges, long waves, K-waves or the long economic cycle) are described as sinusoidal-like cycles in the modern capitalist world economy.[1] Averaging fifty and ranging from approximately forty to sixty years, the cycles consist of alternating periods between high sectoral growth and periods of relatively slow growth.[2] Unlike the short-term business cycle, the long wave of this theory is not accepted by current mainstream economics.”

      • It’s a hard sell.

        So many things have happened just in the last twenty years that seriously effect how the “modern capitalist world economy” works, let alone the last 150-200 years. It’s a struggle to see how any man-made cycle of any sort would remain essentially unaffected.

        • It’s a struggle to see how any man-made cycle of any sort would remain essentially unaffected.

          Should have been:

          It’s a struggle to see how any man-made cycle of that timeframe would remain essentially unaffected.

  7. Re timing…in the shorter term (however long that is) Peter may well be right.
    CB’s will continue to do what they do right to the point of hyper-infaltion. They will certainly go to very high inflation…maybe 20 to 30%.

    So we must be very careful making conclusions in nominal terms.

  8. P.S. I’d rather back the US than anyone else outside Asia at the moment. I intend to put some money there in their real estate.