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The Great Lie Of The Great Rotation

Tyler Durden's picture




 

Both the recent increase in interest rates and renewed questions about the duration of QE3, sparked by the release of the December FOMC minutes, have raised concerns about a 'Great Rotation' out of credit and into stocks. Barclays notes that the story goes something like this: negative total returns in fixed income and increasing equity prices will drive investors to sell the fixed income assets they have accumulated over the past several years and buy stocks. This “Great Rotation” will force investment grade corporate spreads wider. However, in nearly 100 years of data, Barclays finds no evidence of a period when rates rose, spreads widened, and equity returns were positive.

Risky assets are generally correlated, and when interest rates increase, this is usually because of an improving fundamental backdrop that drives risky asset prices higher. Sharp increases in interest rates have happened many times, including several instances post-crisis. In almost all of these periods, credit spreads tightened, as the moves were driven by improving macroeconomic fundamentals.

The few times that higher rates were accompanied by wider spreads happened in the 1970s and early 1980s, when inflation was accelerating. In each of these periods, equity prices fell sharply. As we have been warning, credit spread deterioration has tended to front-run equity weakness (with some false positives) but never with the divergence remaining consistent as a 'rotation' would suggest.

The only outflows associated with higher rates have been small, short-lived, and offset by buying from other large holders, such as insurance companies, which receive stronger inflows when rates are high as their product pricing improves.

 

Via Barclays,

Seemingly predicated on the FOMC Minutes, rates began to rise (and underperform stocks):

  • Several market participants and commentators interpreted the FOMC minutes as indicating a shortening of the duration of QE programs
  • The Summary of Economic Projections revealed that those participants who had factored a continuation of asset purchases into their projections “were approximately equally divided” between those who expected a completion of purchases around the middle of 2013 and those who judged that purchases would be required to persist for longer
  • Although we view the rise in rates following the release of the minutes as overdone, the treasury selloff has stoked concerns about the effect of rising rates on the US credit market

However, looking back at around 20 years of Barclays data, we find that spreads have never widened as rates rose

This relationship also generally holds over a longer time span. The only counterexamples occurred during periods of high inflation where equities sold off as well

Spreads Widen During Inflationary Risk-Offs

The 1970s-early 1980s was the only period in the past 90 years when credit spreads widened during interest rate increases

During that time, the U.S. economy went through several recessions, and inflation was at record highs

  • Credit spreads spiked during the 1974-75 recession and the 1980-82 recessions, periods that corresponded with sharp increases in interest rates
  • However, during each of those periods, equities sold off and underperformed credit dramatically, indicating that the credit sell-offs were reflective of generic risk-off sentiment and not a result of a rotation into equities and out of credit

Furthermore, any mutual fund outflows would likely be balanced by increased demand from insurance and pension funds

With the Fed buying, we find it hard to see how flows into credit could reverse course. And even when the Fed eventually stops, the continuing pattern of flows into credit during the current rising rate environment seem to make a “Great Rotation” unlikely

 

as outflows have tended to be short in duration and small in magnitude...

The historical analysis provides no example of a large-scale reallocation away from credit during periods of rising rates.

 

Source: Barclays

 

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Wed, 02/06/2013 - 15:37 | 3220771 Cult_of_Reason
Cult_of_Reason's picture

Byron Wien: S&P 500 at 1300

"In the second Surprise I projected a decline in year-over-year earnings for the Standard & Poor’s 500 in 2013. Most strategists and analysts are estimating 2012 operating earnings at about $100 and 2013 at $110. I think $95 for 2013 is more realistic. Third quarter earnings in 2012 were down 1.5% for the index and fourth quarter earnings are likely to be weak as well. While there are some positives that should help earnings in 2013, like the recovery in housing and lower gasoline prices, increased taxes are likely to have some adverse impact. Most observers, including myself, believe that the economy is going to have real growth of only 2% in 2013. If that is the case, revenue increases for most corporations will be modest. Some costs will be higher, and profit margins, which are at an all-time high both as a percentage of sales and as a percentage of Gross Domestic Product, are likely to be squeezed. I think earnings will have a difficult time improving under those circumstances.

The stock market does not always react to disappointing earnings, but I think it will this year. Investors are complacent or optimistic, and that often creates the background for a market decline when the news turns negative. We also have the prospect of a battle in Congress over the debt ceiling which is likely to diminish investor confidence. Finally, the deferred sequestration of funds for both defense and healthcare is scheduled for implementation soon and this will take some government purchasing power out of the economy. It will be hard to delay the sequestration further. All these conditions make me believe we will see the S&P 500 at 1300 some time in the first half of this year, more than 13% below the present level. I don’t think we will be in a bear market because valuations are not extreme. By the end of the year the index should regain its lost ground and end about where it started in January."

http://www.blackstone.com/news-views/market-commentary/blog-detail/byron's-market-commentary/2013/02/04/serious-hurdles-ahead

 

P.S. What is the probability of US recession in 2013 from 1.2% payroll taxes drag plus 1.2% sequester spending cuts drag? (Sell-side Wall Street liars on CNBC insist the probability of US recession is 10%. Really?)

http://www.businessinsider.com/bofa-analyst-3-reasons-why-investors-are-too-complacent-about-the-upcoming-sequester-2013-2

Wed, 02/06/2013 - 14:54 | 3220773 AcidRastaHead
AcidRastaHead's picture

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning. Henry Ford

Wed, 02/06/2013 - 15:15 | 3220834 Cult_of_Reason
Cult_of_Reason's picture

When asked what his greatest accomplishment had been during his two terms as President, Andrew Jackson replied "I killed the Bank."

He was talking about the "Second Bank of the United States", which was US second central bank. Though Jackson ended the central bank, it was re-created in 1913 under a new innocuous-sounding name "The Federal Reserve". As a result, soon we will be using Bernanks to buy a loaf of bread.

http://i48.tinypic.com/29pvrdx.jpg

Wed, 02/06/2013 - 14:56 | 3220782 LawsofPhysics
LawsofPhysics's picture

It was possible to raise rates in the late 70's and 80's for a number of reasons that no longer exist.  Go ahead bernanke, "fix it in 15 minutes", I dare you!

I also seem to remember a significant amount of bankers going to jail during the savings and loan crisis (whihc in many respects was a mini-MBS crisis).  Of course the bankers have since changed all the laws, hence 2001, 2008, etc...

Wed, 02/06/2013 - 15:05 | 3220812 zorba THE GREEK
zorba THE GREEK's picture

BTFD

Wed, 02/06/2013 - 15:33 | 3220926 ebworthen
ebworthen's picture

I remember rates of 16% in the 70's, somewhere around 1977?

So, during the Carter inflation years, rates were at least 15% higher than they are today.

Jail?  That's only for kids with a joint and guppy fraudsters like Madoff.

It's not safe to go back in the water!  ("Jaws").

Wed, 02/06/2013 - 14:57 | 3220788 Tsar Pointless
Tsar Pointless's picture

Let me be the first on this thread to say...

...This time, it's different.TM

Wed, 02/06/2013 - 15:00 | 3220797 natronic
natronic's picture

The feds will try all they can including pumping more money into this failed system to keep rates low.  When everyone abandons the bond market for stocks that will signal the beginning of the end.

Wed, 02/06/2013 - 15:09 | 3220817 LawsofPhysics
LawsofPhysics's picture

two questions related to your hypothesis.  1)  what is the total amount of fiat in bonds versus equities (could be a while) and 2) does it matter if the PDs and the Fed are buying 100% of the auction?

 

Many would argue that "everyone" has already stopped buying bonds, with the exception of insiders who are paid off quickly.  Look at the growth in the money supply relative to velocity, there is a fiat dam about to burst somewhere, if it ever does.

Wed, 02/06/2013 - 16:03 | 3221014 Solon the Destroyer
Solon the Destroyer's picture

Natronic,

I'm thinking maybe you didn't read the article.  Bonds generally lead stocks lower, not higher.  You are describing the situation the Sell-siders are trying to sell, which historically doesn't happen, not does it comply with basic economic theory.

And too, this article, and the ones about "rotation" the past few days, are referring to corporate bonds.  A broad selling of corporate bonds won't be a happy event for the general economy, but it is unlikely to signal the beginning of the end.

Not to mention that signal came about 35 years ago.

Wed, 02/06/2013 - 15:05 | 3220810 Solon the Destroyer
Solon the Destroyer's picture

Anyone who believes in a "rotation" should have their Ivy League Econ degree immediately stripped from them.

No such notion can exist in Economics as Pater's article from two days ago stated.  For every seller there must be a buyer. Prices can change but holdings cannot.  There are no holdings of either equities or bonds that is "unowned".

Complete nonsense.  That's why there is no evidence of this "rotation" anywhere in history.

Wed, 02/06/2013 - 15:11 | 3220839 zorba THE GREEK
zorba THE GREEK's picture

But if investers rotate out of bonds, The Fed will be buyer of those bonds or else risk surge

in interest rates. That should cause equities and commodities to rise because more money

has been created and the Fed balance sheet expanded.

Wed, 02/06/2013 - 15:51 | 3220975 Solon the Destroyer
Solon the Destroyer's picture

As I said, prices can change, holdings cannot.  Thus "rotation" is a deliberate misnomer, a word intended to fool the mind.

These articles on rotation have been more about IG paper, and I doubt the Fed is worried about IG having an effect on the Fed rates while the Fed is busy buying so much USG paper.

If you referring to a rotation out of UST's, keep in mind the need for collateral and leverage, and the guaranteed demand for these bonds within the inner investment circles.  They can't use equities the same way.

And also keep in mind the Fed is the largest purchaser of USTs so any such "rotation" would imply that they are selling bonds to buy equities, and while I don't doubt that the PPT buys equities, you and I both know such a "rotation" is not going to happen, ever.

But at the end of the day, none of the above matters when it comes to "rotation".  For every seller there must be a buyer, and that's not first year Econ, that's First Day of First Year Econ.  Even at an Ivy Leaguer.

Someone, somewhere, is holding the paper.

Wed, 02/06/2013 - 15:06 | 3220816 Freddie
Freddie's picture

It's all Bullish.  Everything is Bullish!  Good for 1,000 more points on the Dow.

Hope & Change

Peace is War

Big Dronie (at 30,000 feet with Hellfires) is watching YOU!

Wed, 02/06/2013 - 15:27 | 3220859 Mercury
Mercury's picture

HY is starting to show signs of diverging from equities too.  This usually precedes an equity top.

Wed, 02/06/2013 - 15:17 | 3220866 adr
adr's picture

Yay! I got an order today for $639.00 from a retailer that bought $1.7 million last year. First order from them since November.

Now I need to figure out how to pay rent, payroll, utilities, and taxes and still have enough money to build new product with the $639.00.

YAY RECOVERY!!!!! 2013 FTW BABY!!!!

We were doing around $2.5 million a month in 2012 until November when the orders dried up. Since then my company has only seen $1.5 million in new orders. Since we're private we have no ability to channel stuff valuable stock options into our pockets.

Thanks Wall Street buttfucks for destroying the entire economic food chain, replacing it with whoever bullshits the most and produces the least gets the biggest slice of dough.

Seems the higher the S&P goes, the worse real business gets. 2008-09 was our best year ever because all the publicly traded garbage was dying and retailers desperately needed product that truly sold, they bought a lot of good product from private corporations. With stocks flying ever higher, there is no incentive to carry inventory that actually sells. Channel stuffing to prop up momo stock garbage is all that is going on.

I guarantee if the stock market took a 40% hit, my phone would be ringing off the hook for orders.

Wed, 02/06/2013 - 15:20 | 3220877 ebworthen
ebworthen's picture

No doubt CALPERS and other pension funds are buying into equities at the top.

Normal people with half-a-brain will not be rotating into equities at the top, especially not after 2008, the bailouts, and looking at the taxes on that paystub in 2013.

Fuck Wall Street and their corrupt casino!!!

Wed, 02/06/2013 - 15:22 | 3220883 nwskii
nwskii's picture

Which option play was the most leverage for a dump on Wall street? 

Wed, 02/06/2013 - 15:28 | 3220906 larz
larz's picture

the great rotation from my account into the .05% pockets is about complete

Wed, 02/06/2013 - 15:36 | 3220935 rokka
rokka's picture

Oh no, ZH loves bonds.

Poor bond holders, I woudn't like to be one of them. 

Wed, 02/06/2013 - 15:49 | 3220988 Solon the Destroyer
Solon the Destroyer's picture

Why not?

It's guaranteed profit to front run the central banks.

No one made more money during the First Great Depression than bond speculators.

No one has made more money than the bond speculators in the past few years either.

Other than those buying mortgage paper, the other Front-Run the Fed game.

The smart ones will have plenty of exit warnings.

Wed, 02/06/2013 - 16:05 | 3221029 rokka
rokka's picture

This article IS the exit warning. 

Wed, 02/06/2013 - 15:41 | 3220955 Zen Bernanke
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the bankers kobayashi maru. 

Wed, 02/06/2013 - 16:04 | 3221017 Bam_Man
Bam_Man's picture

It is not a "rotation". It is just $trillions of Central Bank created liquidity sloshing around from one asset class to another. With the Fed placing an indefinite bid under the UST market and the global economy in awful shape, it is only a matter of time before the liquidity sloshes back to bonds.

The fallacy is thinking "you can't make any money in bonds with yields this low". You can if you can pick decent entry and exit points. IMHO we are very close to a good re-entry point.

Wed, 02/06/2013 - 16:11 | 3221051 disabledvet
disabledvet's picture

The definition of "shadow banking" is that the "public rate" is not available to all. That includes "bankrupt Illinois." by targetin LIBOR interest rates in fact are RISING and therefore in conjunction with "no recovery" (or is it an outright Recession? There is no bigger spending quarter than Number 4) means "growth is at a premium." we WISH for equities to go up for that reason. We WISH for Treasuries "to be rotated out of" for that reason. I'm betting against that thesis...FOR NOW. (Obviously equities continue to rally proving my bullish thesis on treasuries wrong.)

Wed, 02/06/2013 - 16:17 | 3221077 FecundaGoat
FecundaGoat's picture

Kinda starting to feel like the 70's to me....I hated the 70's....

Wed, 02/06/2013 - 16:59 | 3221239 Lost Wages
Lost Wages's picture

By the end of the day the Un-Rotation Re-Rotated.

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