For Goldman’s David Kostin, the “great rotation” in markets is as untrue as reports that Hillary Clinton ran a child abuse ring from a Washington DC pizza shop.
“In the realm of investing, an example of “fake news” is the claim by some market participants that a “great rotation” will take place from bonds to stocks,” Kostin, the chief US equity strategist, wrote in a note on Friday. Fake news became a catchphrase during the election for untrue stories from hyper-partisan websites that went viral.
Shortly before the US election and especially after, bond yields rose as investors began to anticipate that interest rates in the US would take off. President-elect Donald Trump’s eventual win raised the expectation that his economic growth plans — involving tax cuts and big fiscal spending — would be inflationary. Combined, these prospects sparked a sell-off in the bond market and lifted interest rates at the fastest pace in seven years.
The outflows from fixed income led some strategists to call the end of the 30-year bull market in bonds, with funds moving to stocks. After the election, flows into equity exchange traded funds (ETFs) were among the largest in years, while inflows to bond ETFs ranked near the largest ever. The elusive great rotation was finally here.
But Kostin said in a note on Friday that investors are not giving up on fixed income just yet.
“Asset migration will not occur for two key reasons,” Kostin said. “First, funds must be sourced from one area before they can be re-invested in another. However, regulatory and policy restrictions limit the ability of many categories of investors to allocate assets away from bonds.”
Kostin pointed to who owns what in the US debt market as an explanation of why there won’t be a great rotation. For example, he said, the Federal Reserve would be unable to rotate its $4.2 trillion in Treasury and agency debt (10% of the market) into equities because it is not allowed to own stocks. Also, it’s much more expensive for insurance companies to own stocks than bonds because of the higher risk.
“Second, several investor categories have debt allocations that are currently at the lowest level in 30 years,” Kostin said. “Debt holdings of these investors may decline further, but a more likely outcome is that bond holdings and allocations remain unchanged and debt as a share of the portfolio falls only to the extent equities appreciate.”
Kostin estimated that a 60-basis-point rise in the 10-year Treasury yield would drop the debt holdings of mutual funds, pension funds and households by 4%.
“Despite the potential for significant value destruction in bond holdings, we expect asset rotation will be limited,” he said, adding that their holdings of fixed income are already near the lowest levels in 30 years.
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