Why Is Everyone Rushing Into Bonds Again?
In February the financial press was alight with the new phrase “ the great rotation”. A term used to describe the theory that investors were piling out of safe haven assets such as bonds and returning to global share markets in droves. This was occurring on the back of very strong performances by the the S&P 500 in the US and the ASX200 in Australia over 2012 and the start of 2013.
As the graph below shows, the great rotation has thrown itself into reverse. This reversal was aided by worse than expected world economic growth indicators, the US Sequester and the Cypriot banking crisis. In Australia the slowing commodities boom, higher unemployment and a worsening federal government fiscal position have all contributed to investors looking for traditional safe haven investments.
Bond Markets
Proponents of the Great Rotation argument have pointed to the decades-long rally in the bond market suggesting long-term charts show that there isn’t much value left in the space. While U.S. government bonds may be richly valued relative to history, they certainly aren’t richly valued relative to many of their peers around the globe. In the United States, for example, 30-year government bonds yield 2.87%. By contrast, the German 30-year yields 2.17%, the Japanese 30-year yields 1.61%, and the Canadian 30-year yields 2.34%.
Commentators are now becoming bullish on bonds based on both U.S. economic data together with technical factors. Treasuries are one of the world’s biggest “safe haven” investments, so when economic growth slows, they tend to catch a bid. The Citigroup Economic Surprise Index just went negative this week, meaning economic data is expected to start being announced further below consensus expectations.
On the technical side, the Federal Reserve is continuing to buy up so much of the market, that it’s making it very harder for investors to get back on the right side of the trade. Rising debt-to-GDP ratios have been cited as a reason to be invested in Treasuries, given “off-balance sheet debt pushing the U.S. above [the 90%] threshold and unprecedented world debt-to-GDP off the charts. That 90% figure, of course, comes from a controversial study by Harvard economists Carmen Reinhart and Kenneth Rogoff finding that high levels of debt relative to GDP slow economic growth.
Equity Markets
Of course bond markets are only one side of the equation. Equity markets have also thrown themselves into reverse, with the ASX200 coming of recent highs and dropping below 5000 points, and the Dow Jones Industrial Average pulling back from all time record highs.
Conclusion
Our view remains unchanged from our earlier article The Great Rotation or The Great Spin. Earnings did not (and do not) back up the increase in stock market values. The world economy remains fragile and susceptible to shocks, evidenced by the recent Cypriot banking crisis. Global economic growth remains subdued and locally the Australian economy seems to be deteriorating with unemployment rising and the federal budget position worsening. As such investors are continuing to seek traditional safe haven assets such as bonds until the global economic outlook becomes more stable. The Great Rotation story seems to have fizzled almost as quickly as it began.
