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MarksJarvis: 'Great Rotation' fails to live up to its name

Investors haven't yet moved large bond investments into stock funds

Gail MarksJarvis

August 14, 2013

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Wall Street has named it the "Great Rotation."

The term presumes that individuals are going to become disillusioned with bond funds after cowering in them and shunning stocks since the 2008 financial crisis. And when that change of heart occurs, the Great Rotation theory suggests, investors will yank massive amounts of money from bond funds and pour it into stock funds instead. Then stocks presumably will soar and bonds will plunge in value.

Watching for the Great Rotation has been a major preoccupation of Wall Street analysts for a couple of years, as they've longed for individual investors and pension funds to believe in the stock market again.

Pundits announced the rotation was kicking in during June, when individuals lost 3.3 percent in the average bond fund and started withdrawing billions from bond funds amid a period of rising interest rates. The theory was that investors were finally ready to dump their bonds and the stock market would keep hitting new highs for the months ahead.

But despite much hype about the Great Rotation this summer, it has turned out to be like a lot of big ideas: not so great. Adam Longenecker, director of quantitative research for EPFR Research, called the recent move out of bond funds and into stock funds a "tiny rotation."

And many investors skeptical about bonds seem to be determined to find a place where their money will be safe, rather than risking it in the stock market, said David Santschi, chief executive of Trim Tabs Investment Research.

Since early June investors have pulled about $96.2 billion out of bond funds, but as of July 29 they had poured $223 billion into savings accounts and other bank products, Santschi said. That flow into safe accounts dwarfed the $41.8 billion that investors put into stock mutual funds and exchange traded funds during the same period.

"There is a rotation, but it's more of rotation from bonds into cash rather than bonds into stocks," Santschi said.

"People still aren't convinced they want to be in the stock market," Santschi said. The stock market has climbed about 18 percent this year, but Santschi said "people regard the rally as an engineered rally" that's been put in motion by the Federal Reserve. "People are suspicious of it and rightly so."

Despite the flow of money out of bond funds, the rotation is small compared with the flood of money into bond funds that has occurred the past five years.

Analyst Nikolaos Panigirtzoglou, of JPMorgan, notes that individual investors put $2.5 trillion into bond funds globally since Lehman Brothers collapsed early in the financial crisis. And despite investors yanking money from the funds lately, the money they have poured into the funds this year still totals $200 billion.

Last year they invested $850 billion in the funds.

Panigirtzoglou doubts that the Great Rotation will materialize as expected. He thinks analysts have misinterpreted the motivations of most investors in bond funds, and consequently assumed a rotation that does not apply. Most of the flow of money in the past five years, he said, has been driven by people trying to save their money. People had been using money market funds previously, but switched to bond funds when money market funds started paying almost no interest.

Savers typically don't suddenly decide to put money into the stock market because they have soured on bonds. And Panigirtzoglou estimates that $1.6 trillion of the $2.5 trillion that individuals invested in bond funds over the past five years can be explained by the money investors pulled out of money market funds.

Although investors who have speculated on bonds may channel money into the stock market instead of bonds as interest rates rise and undermine the value of bonds, Panigirtzoglou estimates that less than a third of the $2.5 trillion that individuals invested in bond funds will rotate into stock funds. So the Great Rotation" may end up good, but not great.

In addition, though some Wall Street analysts have been publicly warning investors that individuals are too exposed to bonds, and not enough to stocks, Panigirtzoglou said that is not the case. He examined 401(k) and other workplace retirement savings plans and found that on average people have plenty of stocks.

Individuals who are heavily invested in bonds could suffer losses in the months ahead if interest rates keep climbing as the Federal Reserve pulls back on bond-buying stimulus. But many people with 401(k) accounts rely on target date funds. Their money is automatically invested in a mixture of stocks and bonds by a professional fund manager. Many of those funds invest about 80 percent in stocks and 20 percent in bonds until a person is in their 40s. Even at 60, many of the funds keep 60 percent or more of the money invested in stocks.

gmarksjarvis@tribune.com

Twitter @gailmarksjarvis