Strategists are hailing the bonds-to-equity rotation – again. But it is no more likely to happen than it was the last time they told us it was imminent.
Back in January 2011, a handful of bank strategists declared that financial markets were on the cusp of a major reversal which they called ‘the great rotation’. The US economy was looking up, so investors would switch from safe but low-yield fixed income into equities that would increase in value alongside gross domestic product. A larger group of strategists predicted the same thing in December 2012, in September 2014, and again in March 2015. All the while, the bonds bull market marched on.
Fast-forward to today, and the so-called great rotation is being hailed yet again. Admittedly, things are a little different this time. US policy rates have risen and the Federal Reserve has given the clearest sign yet that it will hike rates multiple times in the next 12 months. A new US president has promised the biggest tax cuts since the 1980s and a $1000bn fiscal stimulus. The discrepancy between bond fund outflows and equity fund inflows has reached an all-time high.
But what has not changed is investors’ decision-making processes. Insurers and pension funds, which account for about 40% of the investment-grade buy-side universe, are subject to strict mandates regarding their asset class allocations. Another category of investors hedge the interest rate risk on their bond holdings, meaning they are exposed solely to credit spreads. And for long-term investors, the prospect of higher coupons is expected to lure them into new issuance. Retail investors may be looking to ditch their bonds for shares in companies they expect to grow in tandem with the US economy, but other investors are less fickle.
As a result, debt capital market bankers are sanguine about 2017. They point to the fact that two of the world’s most influential investors – Pimco co-founder Bill Gross, nicknamed ‘the bond king’, and DoubleLine Capital CEO Jeff Gundlach – are in a war of words over whether the bull bond market ends when 10-year treasury yields reach 2.6% or 3%. The consensus is that yields will stay around 2.5% for the remainder of 2017.
This is not to say things are not looking up for the equity markets. Valuations, earnings and boardroom confidence are all rising, which should prompt more companies to go public. But this will not come at the expense of the bond market.
