“Great Rotation”is the market theory that states investors are pulling money out of bonds and reallocating into stocks as the 30-year bond bull market runs out of gas and the Federal Reserve scales back its easy monetary policy.
This thesis has been pushed aggressively by Bank of America Merrill Lynch’s chief investment strategist Michael Hartnett.
However, the strategists at Morgan Stanley have long been taking the opposite side of the argument.
Today, Morgan Stanley’s top strategist are out with a massive 72-page paper titled: “Great Rotation? Probably Not.”
“We think the concept of a ‘Great Rotation’ hugely simplifies the nuanced demand dynamics,” wrote the analysts. “Based on our bottom-up assessment of investor segments, covering ~$89trn of assets, and the differing regulatory and demographic pressures on investor decision making, we conclude there are significant, and possibly underestimated, structural challenges to a rotation into equities.”
They identify a couple of big forces we should consider:
We think two opposing rotations may be playing out simultaneously. Since January this year Retail and high net worth (HNW) investors have modestly reduced cash/near cash and increased risk assets. Global (equity and fixed income), income, and multi-asset products have been in particular demand. More recently, mutual fund flow data suggest a modest rotation out of fixed income and into equities, as confidence in economic growth has risen. (This trend was even stronger for money market funds in mid-2013, suggesting shifts more readily here than into equities). Against this, we see Institutional investors (Insurance and Pension schemes) doing almost the opposite — despite the risks to fixed income portfolio values from a rising rate cycle. Insurers facing Solvency II regulations and Defined Benefit Pension schemes needing to immunize risks are still reducing their equity weightings.
Institutional de-risking could outweigh much, if not all, of any increased equity appetite in Retail. Defined Benefit (DB) and Defined Contribution (DC) Pension schemes represent ~45% of global equity investment, we estimate. Our analysis suggests this group will be a powerful headwind to any longer-term rotation back into equities, offsetting any cyclical re-risking from Retail and HNW investors.
In other words, mum and pop are buying stocks, and pensions and insurance companies are selling. And the latter may be a bigger force than the former.
However, Morgan Stanley adds that the ageing of mum and pop is preventing them from investing too aggressively.
“[W]e think ageing demographics and lower risk appetite will focus investor demand on regular income, capital preservation and lower volatility of returns, limiting the strength of any rotation into core equities,” they write.
But they also point to the cash on the sidelines as a potential source of equity inflows.
“But if risk appetite picks up, it could translate into re-allocation from cash into risk assets,” they say. “We think Retail and HNW investors are more likely to chase market performance. Cash balances for private banking clients are still above longer-term averages.”
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