The title of fund manager and noted bear John Hussman’s weekly note: “Capitulation Everywhere.”After a steady grind higher in stock markets to start 2013, Hussman is feeling pretty lonely in the bearish camp.
He writes, “The bears are gone, extinct, vanished. Among the ones remaining, many are people whom even I would consider to be either permabears or nut-cases. And yet, the historical evidence for major defensiveness has rarely been stronger.”
Hussman also takes aim at the biggest catchphrase to emerge in recent market commentary: the “Great Rotation.” The idea is that 2013 will finally be the year where large amounts of investment funds flow out of bonds, which have had an incredible run over the past 30 years, and into stocks. This rotation largely underpins Wall Street’s call that stocks (proxied by the S&P 500) will appreciate another 10 per cent in 2013.
Hussman says strategists and fund managers touting the “Great Rotation” idea – even including Ray Dalio – seem to misunderstand how markets work altogether.
In his note, Hussman writes:
The newest iteration of the bullish case is the idea of a “great rotation” from bonds and cash to stocks, as if the outstanding quantity of each is not held by someone at every point in time.
The head of a “too big to fail” investment firm argued last week that stocks are “underowned” – as if every share of stock presently in existence is not actually owned by someone. To assert that stocks can be “underowned” seems to reflect either a misunderstanding of how markets work, or a desire to distribute overvalued institutional holdings onto the unwashed muppets.
Likewise, the idea of a “rotation” out of bonds and into stocks begs the question of who will buy the bonds and sell the stocks, as someone must be on the other side of that trade. Similarly, to “move cash into the market” requires a seller of stock who becomes the new holder of said cash.
Quite simply, the reason that pension funds and other investors hold more bonds relative to stocks than they have historically is that there are more bonds outstanding, relative to stocks, than there have been historically. What is viewed as “underinvestment” in stocks is actually a symptom of a rise in the gross indebtedness of the global economy, enabled and encouraged by quantitative easing of central banks, which have been successful in suppressing all apparent costs of that releveraging.
The “rotation” fallacy has emerged even in the work of analysts that we admire. Ray Dalio of Bridgewater talked on CNBC last week of a move “out of” cash and “into” stocks, seemingly reversing comments he made only weeks ago at the Dealbook conference (h/t PragCap) where he suggested that risk premiums are likely to expand, that the effects of QE are diminishing as we do more rounds, that we’re facing austerity, that growth is flagging, that the economy is facing unprecedented risk, and that we face a slowdown with very little room to manoeuvre.
Meanwhile, Albert Edwards of SocGen suggested that there has been an excessive “move away from equities” in recent years – instead of noting, for example, that the volume of U.S. government debt foisted upon the public (even excluding what has been purchased by the Fed) has doubled since 2007, not to mention other sources of global debt issuance, while the market capitalisation of stocks has merely recovered to its previously overvalued highs.
But the problem with the “great rotation” argument is that somebody has to hold the debt. Somebody has to hold the cash. It cannot go anywhere, and it is impossible – in aggregate – for the markets to “rotate” out of it.
Hussman says conditions are ripe for a sell-off in the stock market. Click here to read more from his latest note >
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