Some See ‘Great Rotation’ Beginning

November 28, 2016

(Reuters) – After a number of false starts since the term was first coined five years ago, the idea of a “great rotation” out of bonds into stocks is again gaining traction.

Almost $2 trillion has been wiped off the value of global bonds since Donald Trump was elected as the next U.S. president on Nov. 8, sparking a reassessment of growth and inflation views. In contrast, U.S. stocks have hit record highs.

According to Bank of America Merrill Lynch, the week to Nov. 16 saw the biggest equity inflows in two years, at $28 billion, and the biggest bond outflows in 3 1/2 years, at $18 billion—the widest weekly disparity between stock and bond flows ever.

Whether this marks the start of a “great rotation,” a phrase first used by Bank of America in 2011, remains to be seen, but there are two reasons why this time it could be the real thing.

Why This Could Be Real Thing

For starters, say analysts, a tighter U.S. jobs market and signs of stronger economic growth suggest inflation risks are rising.

Second, for the first time since the financial crisis, there is a shift toward fiscal expansion—highlighted by the economic policies favored by Trump and by Britain's budget statement this week that unveiled a $29 billion fund for infrastructure projects.

That change implies higher borrowing by governments and another source of inflationary pressures that support a view that an era of ultra-low-yielding bonds may be in the past.

The only caveat is that this notion of investors shifting their hundreds of billions invested in bonds into stocks as a three-decade bond bull run comes to an end, propelling equity markets higher, has had several false starts before.

What’s Different This Time

"I've been asked this question many times before—about whether we're seeing a great rotation," said Luca Paolini, Pictet Asset Management's chief strategist. "We now see some significant inflation risks that were nonexistent before. This is what's different."

In Germany, signs of a pickup in inflation pushed yields sharply higher from record lows between late April and June last year—only to fall back as data suggested the region continued to battle with deflationary pressures.

U.S. 10-year bond yields rose more than 100 basis points during the so-called taper tantrum of 2013 as investors positioned for a scaling back of U.S. monetary stimulus. They subsequently fell back too, hitting record lows earlier this year, helped by a perception that any Federal Reserve monetary tightening would be gradual to support growth.

A Fed rate hike next month, widely expected, would mark the first increase in a year.

 

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