Why The End Of The 'Equity Cult' Means Trillions In Upcoming Outflows From Stocks

Tyler Durden's picture

Citi's Robert Buckland is out with the must read report of the weekend, especially for all the optimists who believe that despite the ongoing depression (and as many have demonstrated, all the talk about a double dip is moot, as America has never left the depression, or as Rosie calls it a period of prolonged economic subpar activity: the latest NFP number merely reinforces the theme of economic deterioration), and despite the 17 weeks in retail equity outflows (which would be a contrarian signal if there was hope that retail would ever feel safe enough to return in stocks. After nearly 5 months of no change in trend, the debate can be put to rest, if at least for 2010) there is still hope. There very well may not be - Citi has just pronounced the "Equity Cult" dead: "It has taken 10 years, and two 50% bear markets, to reverse this cult. European and Japanese equities are already trading on dividend yields above government bond yields. US equities are almost there as well. An immediate reincarnation of the equity cult seems unlikely. Global corporates, especially the mega-caps,  rushed to exploit cheap financing as the equity cult inflated. They have been slow to redeem equity now that the cult has deflated. Equity oversupply remains a drag on share prices." And as more and more companies and investors shift to a de-equitization theme, the trendline in allocation for the US pension assets will soon revert to that seen when the "Equity Cult" began, or roughly 20% of all assets, with bonds taking on an ever greater precedence of asset allocation (incidentally the UK is already back to the equity/debt relative investment levels of the early 1960s). What does this mean for capital flows? "A reduction in equity holdings back to pre-1959 levels (around 20% of total assets) would indicate considerable selling pressure to come. For US private sector pension funds alone, that would imply a further $1900bn reduction in equity weightings. The evidence suggests that there could still be considerable institutional selling to come."

So let's recap what the medium- and long-term trends for the market are:

  • $2 trillion in equity sales from pension funds alone as capital flows normalize now that the "Equity Cult" is dead
  • A seemingly endless push into fixed income by an aging demographic meaning billions more in ongoing monthly domestic stock mutual fund redemptions
  • Hedge funds which are underperforming the market massively, and which will see an explosion in redemption letters as the end of Q3 approaches
  • An inevitable change in the tax regime over the next 4-5 months, which as Guggenheim pointed out, will force investors to sell billions in stock to catch a sunsetting beneficial capital gains tax.

And yet what happens - the market surges on a negative NFP number that was negative but better by a factor of noise, compared to whisper expectation, as robotic traders pick up on the positive feedback loops to take the market higher one more time as soon everything collapses.

For all those who believe in 17x forward P/Es (expecting a 20% rise in corprate earnings in 2011 with a flat GDP indicates a serious overdoes on medicinal hopium) - Good luck chasing the bouncing ball.

For all those others, who feel like micturating upon the grave of the "Equity Cult" here are the highlights from the Citi report.

Bond vs Equities - Then and Now (this will be familiar to all those who have read Albert Edwards' recent pieces):

In July, global equities rebounded despite continued falls in government bond yields. This defied the strongly positive relationship between equities and bond yields seen since 2000. Many equity investors worry that this decoupling will be resolved by the bond markets being proven “right”. The implications of this are worrying — the last time US treasury yields were down at these levels, the S&P (currently 1050) was nearer 800.

We have pointed out that equities actually have a decent track record when these decouplings have occurred in the past1. Certainly Citi’s equity and bond market forecasts suggest that this current breakdown in the relationship is more likely to be resolved through rising bond yields than falling equity prices. However, we also understand that many investors think we will be proven wrong.

We can’t help but suspect that this hot debate about the relative attractions of bonds against equities — whether one is pricing in the double dip but the other is not, whether one is pricing in deflation but the other is not — is mere froth on top of a much more profound reassessment of the merits of the two asset classes. In particular, has the “cult of the equity” been replaced by the “cult of the bond”? To answer this we first take a look at the origins of the cult of the equity.

The rise of the cult of the equity is reflected in institutional asset allocations. Figure 3 shows the weighting of US private sector pension funds in equities and fixed income as derived from the Fed’s Flow of Funds data. Back in 1952, US private sector pension funds held just 17% of their assets in equities compared to 67% in fixed interest. Over the next 50 years, these weightings reversed — at the peak in 2006, the same funds held 69% in equities and 18% in fixed interest. Of course, some of the increase in equities will reflect the outperformance over the period.

The picture looks similar in the UK (Figure 4). Back in 1962, ONS data suggest that UK pension funds held more in bonds than equities. That reversed in the 1960s, as equity weightings increased aggressively. At the peak in the early 1990s, UK pension funds held 76% of assets in equities compared to just 12% in bonds. It seems that UK pension funds embraced the cult of the equity more enthusiastically than their US counterparts, perhaps as a result of a desire to buy equities as a hedge against the UK’s more significant inflation problems.

We can also see the rise (and fall) of the equity cult in mutual fund flows. Figure 5 shows US mutual fund equity inflows going back to 1984. These peaked above $300bn in 2000. European fund inflows peaked in the same year at €180bn (Figure 6). US equity inflows recovered as markets rallied in 2003-07. European equity inflows did not.

Why the cult is now dead?

It seems that the cult of the equity began in the late 1950s. Why? Many justifications have been put forward. Most obviously, the 1950s marked the beginning of a welcome period of peace and prosperity following a tumultuous 50 years that included two world wars and a major economic depression.

The rise in equity weightings coincided with Markowitz’s first considerations of modern portfolio theory. This promoted the belief that a well-diversified equity portfolio could achieve superior returns while helping to reduce risk. It was clearly the view of George Ross Goobey, manager of the Imperial Tobacco pension fund who was generally perceived to be the godfather of the cult of the equity in the UK. Ross Goobey liquidated his entire fixed interest portfolio in the 1950s and invested the proceeds in equities. This was highly controversial at the time — he was banned from teaching students at the UK Institute of Actuaries.

Other factors may have helped to promote the cult of the equity. Most pension funds were relatively immature back in the 1950s, so giving them a better ability to absorb short-term equity volatility in search of longer-term returns. Equities were seen as a good match against the wage-driven liabilities of defined benefit pension schemes. Equities offered a decent inflation hedge long before index-linked bonds were ever invented. This characteristic was particularly attractive in the 1970s and 1980s. The list of academic justifications goes on and on.


But perhaps most convincing is the argument that the cult of the equity was the product of a period of spectacular  outperformance from the asset class. This became self-fulfilling. Pension funds bought more and more equities because they kept outperforming. Insurance companies (except in the US, where their exposure to equities has been limited by law) and retail  investors couldn’t resist the same trade. Figure 7 shows the annual returns from US equities and government bonds divided into decades since the 1920s. We also show the annual returns for the total period.

Since 1920, even including the dreadful experience of the last decade, US equities have generated a healthy annual return of 10.9% compared to a bond return of 6.1%. The most spectacular equity performance (especially relative to bonds) was not in the roaring 1920s, 1980s or 1990s, but in the 1950s. Perhaps this is what brought investor attention back to equities. It took  many years for the wounds of the 1929 crash to heal — US equities only managed to regain their pre-1929 crash levels in 1954. But from there, a new 40-year love affair with equities began. The 1970s were tricky, but equities did no worse than bonds. Indeed, by the end of the 1990s, the long-term outperformance of equities over bonds looked truly spectacular. $100 invested in US equities in 1950 would have been worth $58,380 at the end of 1999 versus $1,651 in treasuries. Those two numbers probably say more about the cult of the equity than any long academic study.

Why Is There A Cult Switch?

The evidence suggests that the cult of the equity began in the 1950s and peaked in the late 1990s — that’s a 40-year bull market. Since then, it seems that the investor love affair with equities has soured.

Many of arguments associated with the cult of the equity have since come under attack. Inflation seems much less of a problem. Equities have never been particularly good at hedging inflation anyway, and now index-linked bonds can do a much better job. The long duration of the equity asset class becomes less desirable for pension funds as populations mature and retirement dates approach. Defined contribution investors (where the individual takes the risk) may be less willing to tolerate volatile equity returns than the old defined benefit plans (where the employer takes the risk).

But most importantly, it is dreadful returns that are increasingly putting investors off equities. Since the end of 1999, global equities have returned just 4% in total. Not only have equity returns been trivial, but the volatility has been brutal. Having two 50% bear markets in one decade is enough to test the patience of the most determined equity cultist. Just as strong returns helped to build the cult of the equity in the 1950s, so weak returns are tearing it down now.

Investor appetite for global equities is falling. Figure 3 shows that in 2009 US private sector pension funds held 55% of total assets in equities compared to 70% in 2006. Figure 4 suggests that UK pension funds cut their equity weighting to 39% in 2009, down from the 76% high in 1993. The 2009 rebound in equity prices has helped to reverse some of this decline in equity weightings, but most investor intention surveys suggest that the secular reduction in equity weightings is likely to continue.

How much worse will it get?

How far could this go? A reduction in equity holdings back to pre-1959 levels (around 20% of total assets) would indicate considerable selling pressure to come. For US private sector pension funds alone, that would imply a further $1900bn reduction in equity weightings. The story looks similar amongst retail investors. Equity inflows into US mutual funds have not recovered from the 2007-09 bear market (Figure 5). European equity inflows never recovered from the 2000-03 bear market (Figure 6).

The evidence suggests that there could still be considerable institutional selling to come. Developed market pension funds have cut their equity weightings from peaks but there is still a long way before they get back down to pre-cult levels. For a broader global comparison, we look at the 2010 Towers Watson Global Pensions Assets Survey (Figure 8). Given different data samples, this might not correspond with the long-term historical data series that we have already shown for the US and UK, but it is a useful guide to regional variations.

What does Japan teach us?

Japan may be a useful guide to an unwinding equity cult. According to Towers Watson, in 1998 Japanese pension funds held 55% in equities, still remarkably high given the dire performance of the Japanese market through the decade. Japanese pension funds now hold 36% of total assets in equities and that number seems likely to head lower. Bonds have been the key beneficiaries of equity outlflows. Elsewhere in the world, Australian pension funds have a high equity weighting although our local strategists have argued that the compulsory superannuation fund structure has embedded the equity culture more firmly than in other parts of the world. Continental European funds are already firmly tilted away from equities towards bonds, so the scope for further equity outflows might be more limited.

Emerging Markets remain one bright area amidst the gloom. Figure 9 shows annual global equity inflows as measured by EPFR. This confirms the sorry state of developed market inflows, but it also shows that the appetite for Emerging Markets equities has been much more robust.

The cult is dead. Long-live the cult

As the cult of the equity fades, it is being a replaced by a new cult of the bond. It is argued that bonds are more appropriate in a world where deflation, not inflation, is the main threat. Liability Driven Investing (LDI) advocates usually promote the liability-matching benefits of bonds over equities. Ageing populations would seem to favour bonds over equities — most “lifestyle” pension schemes automatically switch equities into bonds as a worker approaches retirement age. Perhaps most importantly, bonds have handsomely outperformed equities in the past decade. Since 2000, global equities have returned 4% (0.3% per year), while global government bonds have returned 103% (6.9% per year). The list of factors favouring bonds is as long as that favouring equities back in the 1990s.

These arguments are reflected in rising pension fund bond weightings (Figure 3 and Figure 4). We can also see that mutual fund inflows now favour bonds, although not yet as consistently and heavily as they favoured equities in the late 1990s (Figure 5 and Figure 6).

But even if there is no bond cult, the stock chasing era is over: Conclusion

Of course we can (and will) carry on arguing about whether bonds or equities will be proven “right” after the recent decoupling. We can (and will) carry on arguing about the likelihood of a double-dip in the global economy. We can (and will) carry on arguing about whether the developed world is heading into a Japan-style deflationary spiral. Each outcome should have meaningful implications for the direction of global equity and bond prices.

However, we can’t help wondering if this misses the point. With the notable exception of Emerging Markets, what is really going on is a long-term shift in investor appetite for equities and bonds. It will take more than the avoidance of a double-dip to turn the equity outflows around. Sure equity prices would probably rise in the short term if that were to happen, but a sustainable rerating could only be achieved if investors were to be attracted back to the asset class. Although likely to be painful in the short run, an inflation-inspired global bond sell-off would probably offer the best chance of that happening. That still seems pretty unlikely for now.

The Citi view on the outlook for the global economy could be best described as “uninspiring, but not disastrous”. But rather than furiously arguing about whether that view is right and if it is already reflected in share prices, perhaps we would be better served by accepting that, from a valuation perspective, it is what it is. For all sorts of reasons, both cyclical and structural, equities are likely to remain “cheap” against bonds for some time yet.

So it is what it is. Investors are unlikely to pile back into global equities any time soon. It looks like they are likely to sell weightings down and move further into bonds. This is convenient for government bond issuers given that they have such vast amounts of bonds to sell. Equity and bond valuations will continue to reflect these flows. Maybe global equities can move higher with rising profits but, outside Emerging Markets, the prospect of a 1980/90s-style rerating still seems a very long way off.

Indeed, it is what it is: you can't fund a trillion dollar bond bubble, and see equity allocations at the same time. There is a reason why Albert Edwards sees the S&P in the 400 range: you can't have an increasingly more frugal investors buying both, and you can't have central banks buying everything without risking a completel collapse in the faith of all currencies. In retrospect, it is really simple. There are those who believe they are immaculate daytraders, and believe they can make money chasing everything dip in stocks. We wish we had their skill. Since we don't we would rather put our bet on where the age old adage of follow the money says stocks willl end up going. And that is much, much lower.

Full must read report.


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Steak's picture

I present for y'alls listening pleasure, another two playlists.  The first is a mix of new and recent EDM productions, many of which can melt faces.  The second is for all y'all who like to funk it up, with an EDM twist of course.

2cool (4skool) <ass-kicking>: http://www.youtube.com/view_play_list?p=12689F04C0CEEF6C 

up with the get down <funky fresh>: http://www.youtube.com/view_play_list?p=4217E3682ABFEFB9 

Steak's picture

Keep on pimpin, pimpin :)

kathy.chamberlin@gmail.com's picture

yeah funky electronic dance music, FEDm. new 2 me. you got it all, my man,

ya got it all.

rocker's picture

I needed that. Now for bottle of Bass Ale.  THX

kathy.chamberlin@gmail.com's picture

HAIL to my new M A E S T R O.

Sudden Debt's picture

Just got a call from the FED, Benny said he'll cover that. So no probs!



assumptionblindness's picture

I don't understand why the fuck your comment got junked...good weekend to you too!

Sudden Debt's picture

Mormons... what can I say... :)

ebworthen's picture

I'm in Utah, not Mormon, loved it.

Rock on.

Sisyphus's picture

You are an effin' riot. :>}

-1Delta's picture

OMFG im so full of Kool- Aid after today's data im not sure if I can go drink this weekend

rocker's picture

Finally someone mentioned the "Supply" factor and what it means.

I thinks you are rights. Bennys going to be addings to his supplys.

I abused the Ss and Benny is abusings our taxes moneys.

This has been going on for 6 years. How much stock can the FED buy?

Audit the Fed, nows.


TraderTimm's picture

Equities go higher - until they don't.

Damn right. Buying PUTS on the close this Friday, don't want to miss the downturn train!

(Even if I have to take 100 points or so of 'heat', it will be worth it.)

tunaman4u2's picture

The more Puts & Shorts we put on the more HFT can take from us... we're better off being OUT of the market & forcing them to feed on Longs instead. 

SheepDog-One's picture

I agree, let the FED crooks flop around there pumping to no one all by themselves. Make the FED the all-time record bagholder.

DosZap's picture

Bingo..............let them PLAY by themselves for a while.

Why feed the friggin leeches?.Let em' rot.

Sudden Debt's picture

The longer Benny waits, the more messy it'll get and at the end it will only cost more to "rebuild/buy" the economy.


I am more equal than others's picture

Scobby Do says "uh oh"

rle1221's picture

one question please. if all these funds are going to sell, whose left to buy?

SheepDog-One's picture

The FED already has what, $2.2 trillion worth of equities a junk real estate purchases? MIGHTY big bag the FED is holding there!

Mad Mad Woman's picture

Nobody.  Maybe the Fed. Nobody's going to be in a hurry to buy anything for a while.

zoomer's picture

I'm with you, Girl,  I like my trashy cash!

AccreditedEYE's picture

RLE: It's not a "one and done" the implications of this are long term and will play out so. With less capital flowing into the "equity" allocation in 401k and pensions, there is less firepower for the asset class to perform as most have been used to in the past. Multiples will contract and prices come down. Volatility will, despite today's performance, increase. In a nutshell, much less wind will be flowing into the sails of equity for a long time to come. Of course, the short answer is the Federal Reserve... LOL!!

midtowng's picture

Speaking of withdraws, has anyone else noticed this yet?


In Afghanistan, investors in Kabul Bank are counting on U.S. support to stem a run on the country’s largest bank.

“America could support Kabul Bank to the last penny,’’ Mahmood Karzai, the Afghan president’s brother and largest bank investor, said in a WSJ interview. “The full faith and credit of the U.S. government behind the Kabul Bank–what more could you want?”

Afghanistan, which is receiving billions in humanitarian and military assistance from both the U.S. and Europe, is arguably a ward of both those states. What’s a few more billion to back up a failing Afghan bank?

Another reason bolstering Kabul Bank’s argument for a bailout: Its executives seemed to have followed the western play book for ruining their bank.

As the WSJ points out, Kabul Bank is accused of giving “clandestine” loans to themselves and Afghan government insiders.”

centerline's picture

As the WSJ points out, Kabul Bank is accused of giving “clandestine” loans to themselves and Afghan government insiders.”


I guess we taught them well.

SWRichmond's picture

Wait, you mean that government is, by definition, corrupt? 

Who knew?

knukles's picture

Whadday want?  How's about some of that $8 billion of US money just disappeared.

Owhhhh.... I got another one!  Is this piece of shit bank audited by any credible outside entity?  Betcha answer is "FuckNo".  Just like the Fed, "FuckNo".  No Audit. 

So, let's all just sing along....

So where oh where did the money go,
Oh where oh where can it be? 
In the pocket of an Kazari man,
Or a representative from DC?

Ya' just can't make this shit up, ya' know? 
If there were to be answers instead of indignation and threats, then there'd be an audit, like are done in some real, honest countries.  Somewhere.

Time for a Thorazine and Ativan Enema with a sooting Jerry Springer tape. 
(Quite Sobs)

Translational Lift's picture

"Mahmood Karzai, the Afghan president’s brother and largest bank investor"

This Mother-Fer is the largest poppy grower, drug dealer, crook, crime syndicate in Afghanistan.  He probably has the bank's funds in a Swiss bank along with his other funds..........

kathy.chamberlin@gmail.com's picture

stoner dude. splendor in the grass.

Mad Mad Woman's picture

Wow.  Very interesting read.  Time for some changes.

SWRichmond's picture


The government's ability to pay off debt is directly related to growth in the tax base and therefore, of course, the underlying economy.  The "Cult of the Equity" must be seen for what it was: a cult of faith in the productive capacity of the economy, and a willingness to invest capital in actual productive economic activity.  That faith is the thing that has died, and will not be reborn due to demographic as well as other factors (regulatory malfeasance, tax policies, etc). 

The flight intoTreasuries might make the government's balance sheet possible, but only temporarily, as it also guarantees that productive economy activity will NOT occur in the future.  Government borrowing and spending is not productive, as the chart linked above shows.  Government borrowing is strictly for consumption.  Debt is only productive when some of it is directly invested in actual productive economic activity.  In my humble opinion, the marginal productivity of debt has gone negative as a direct consequence of the dominance of unproductive sovereign borrowing.  As such, the dominance of sovereign borrowing virtually guarantees the collapse of the revenues upon which sovereign debt repayment relies.  The federal government is eating its tail.

centerline's picture

As bonds go, so do stocks.  Nothing shows the monumental effort being put into propping up this zombie economy than the current decoupling.  Talk about pissing into the wind.

SheepDog-One's picture

Bonds are acting as if a huge meltdown in stocks has already been ongoing for the last few weeks! MONUMENTAL pumping going on to keep this equity bubble inflated! 'Just 1 more day' is their morning rallying cry I believe.

vote_libertarian_party's picture

Pull up a chart with TBT and SPY.  Bonds spiked in January 2009.  Stocks (you know, the retarded little brother) didn't hit bottom until 3 months later.


That timing could be repeating.

SheepDog-One's picture

BTW, whoever junked THIS post, well I hope you die of cancer of the anus! Youve got to be a REAL fuktard!

ElvisDog's picture

I'm a little slow this morning. Bonds up means money is flowing into bonds, which means less money is flowing into stocks. Can both bonds and stocks go up in price on a long-term basis?

camoes's picture

70's  "stocks are dead" = bull market

90's "internet stocks are hot" = bear market

00's "CDO's are hot, high return, safe investments" = Depression 2.0

Shittybank says stocks are dead = BUY BUY BUY BUY buy them all bitchez

functionform's picture

Yeah I'm kind of with you there... Equity outflows being mutual funds?  Isn't that the 'dumb money'? 

DosZap's picture

Not necessarily, it can be the 401k schmucks, that have ZERO choices.Worst part, is what's left for them, Bonds,and T Bills.

Out of the pan,into the fire.

SheepDog-One's picture

Dont let Leo in on the fact that equities are due for a huge crash, he'll get all uppity and put up some solar stock chart that gained 8 cents again.

RobotTrader's picture

Euro is making new highs for the move.

CRB Index still going up.

Financials are outperforming the last two days.

Yet, everyone is buying puts hand over fist.

Eventually the outflows from mutual funds will reverse.

Maybe after the S & P 500 is up 30% from these levels, people will start paying attention to stocks and forget about real estate.

For now, everyone is still shorting all rallies.

SheepDog-One's picture

Puts hand over fist, at year high? How do the pumpers get around that? Think I'll load a bunch too on Tues morning.

AccreditedEYE's picture

CRB Index still going up- To the non-elite, this acts as a tax, killing off consumption. (especially when wages stay flat/negative)

Financials are outperforming the last two days- Leaders of the last Bull are NEVER leaders of the next one.

Eventually the outflows from mutual funds will reverse- Don't count on it, at least not for the long term. Demographics are against you Robo. :)