Fiscal Cliff: The Great Rotation of 2013
As if Americans don’t have enough to worry about with the impending fiscal cliff; now there is a greater long-term danger laying in wait in dark financial corners for 2013. Its called the “Great Rotation”!
A ‘great rotation’ is a cyclic general swing by investors away from buying bonds into buying stocks. Sounds innocent enough, but this time will spell big trouble for long-term U.S. federal government debt.
There are numerous reasons investors feel the time is ripe for another great rotation.
The Dynamics of a Great Rotation
According to experts the reasoning behind a rotation are quite simple. Stocks become risky for one reason or another, lose money and so skittish investors head for safer investments to prevent losses from volitile or declining stock values.
Those investments are into lower-yield ‘safe-haven’ government bonds, like U.S. Treasuries. That happened in earnest in 2008.
That drives down bond yields, often helped by central bank monetary policies, and the return on investment in bonds dwindle over time. Once the point of diminished returns is reached then investors start pulling money out of bonds and put it back into higher-yield stocks again.
Then, over time, bond yields rise again making them more attractive when yet another recession or financial crisis comes along and the pendulum swings back into safe haven bonds once again.
It is a fundamental rotation in investment strategy with about a 30-year cycle.
What the Experts are Saying
Speaking on bond markets, here are some insider comments in recent months.
Everyone is shaking the bushes pretty hard to find yield, but there’s not much left
– Jay Mueller, Wells Fargo, Financial Times quote, 12/28/2012
Are we in the midst of a bond bubble?
– Ben Levisohn, “The Silence of the Bond Bubble“, 12/28/2012
The age of bond outperformance has ended
– Michael Hartnell, Merrill Lynch, Marketwatch, 10/11/2012
We’re in the “final inning” of the three-decade bond bull market
– Michael Aniero, Barron’s, ‘Great Rotation into Stocks in 2013‘, 11/23/2012
One of the RIC’s highest conviction investment themes expected to play out over the next few years is the Great Rotation from bonds and into stocks.
– The RIC Report, 4/10/2012
The shift appears universally predicted. Among the reasons cited are:
- Record low bond yields
- Signs of economic recovery
- Central bank accommodative monetary policy
The harbinger of a quiet great rotation has already appeared.
Unlike equities, bonds have a limited upside and represent only a small portion of overall daily trading. Barron’s reports in 2012 that bonds represented 0.29% of daily trades. It is down from 0.39% in 2011 and 0.5% in 2010. The Financial Times reported yesterday that bank bond sales are at a 10-year low.
It means that The Fed’s $85 billion/month Treasury purchase program to keep interest rates low is swimming against the current. The natural shift is away from Treasuries by investors and into higher-yield equities in a slowly improving economy. They’ve squeezed all the profit they can from Treasuries.
It is ironic that the monetary policies The Fed is using to strengthen the economy will naturally drive interest rates higher as the shift away from Treasuries continues.
What is different this 30-year cycle is that the federal government has a huge national debt over 100% of GDP. Servicing that debt will become more and more expensive within this natural economic cycle.
Interest costs are already $400-500 billion/year to service that debt. That’s almost half the yearly federal deficit right now. In a few years, with rising Treasury yields, it’ll grow into the entire federal deficit.
Fiscal cliff or no fiscal cliff…
When that happens drastic spending cuts and tax increases will become necessary to fix it.