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Here Comes The Next Great Rotation: Out Of Stocks And Into Bonds

Tyler Durden's picture




 

One of the biggest stories of 2013 was the so-called "great rotation" that was supposed to take place out of treasury funds and into equity funds. And, for a few months, it actually did take place only to see itself unwind promptly, resulting in 10 Year yields now roughly where they were in May of last year despite everyone's eager wishes to punch, kick and scream the 10 Year north of 3% yield. After all, not even the most demented permabull will dare to make an optimistic case when the 10 Year is saying there is absolutely no chance of pick up in inflation and nominal economic growth (that the bond and equity markets are both rigged, and manipulated by the Fed is a different matter entirely).

However, if the great rotation out of bonds into stocks was the story of 2013, it now appears that 2014 will see another great rotation - a mirror image one, out of stocks and back into bonds, driven on one hand, of course, by the Fed which will continue to monetize the bulk of net duration issuance for the foreseeable future, but more importantly, by some $16 trillion in corporate pension assets which after (almost) recovering their post-crisis high water market are once again, will now phase out their risky holdings in favor of safe (Treasury) exposure.  As Scotiabank's Guy Haselmann explains, "The rationale is quite simply that the cost/benefit equation changes as the plans’ funding status improves. In other words, the upside for a firm with a fully-funded plan is less rewarding than for an under-funded plan."

Needless to say, the Fed, which is doing everything in its power to push marginal buyers out of a bond purchasing decision and instead to chase Ponzi risk into equities, will not be happy, especially since QE is tapering, and suddenly instead of everyone frontrunning the Fed, the momentum chasers will proceed to scramble after the largest marginal players around - pension funds, which however will be engaging in precisely the opposite behavior as the Fed!

As Haselmann concludes: "Given the decline in market liquidity and so many investors chasing the same crowded riskseeking trades, these pension flows could have a material impact on market prices for the remainder of the year. Currently, most portfolios remain over-weight equities and high yield and underweight Treasuries and short duration. However, I expect portfolios to reconsider these weightings. With this in mind, and due to factors outlined in notes earlier this week, I remain bullish on long-dated Treasury securities."

More detail in Guy Haselmann's full note below.

From Scotiabank:

Private Defined-Benefit Pension Plans

There are several reasons to expect substantial changes in the asset allocation policies of corporate pension plans. Those changes should result in a significant volume of assets moving from equities and other return-oriented investment classes into lower-risk liability driven (LDI) investing strategies.

A distinction should be made between public and private pensions and between defined benefit (DB) plans and defined-contribution plans (DC). This note focuses strictly on private DB plans. There are around $16 trillion in corporate pension assets in the US of which approximately 43% are DB plans. Many of these plans were materially underfunded (more liabilities than assets) after the 2008 crises. However, after years of QE and resulting asset price inflation, a large portion of these funds have returned to near fully-funded status (97% levels on average according to most estimates). Russell Investment analysis shows an improvement of almost 15% in 2013 alone.

The trend in recent years has been for plans to adopt some type of LDI approach. This trend means that plans have adopted policies that systematically reduce investment risk as funded status improves. The rationale is quite simply that the cost/benefit equation changes as the plans’ funding status improves. In other words, the upside for a firm with a fully-funded plan is less rewarding than for an under-funded plan.

  • Accounting plays a crucial part in this equation. The stream of payments made by a DB plan (the liabilities) is discounted back to a present day calculation in order to  generate a targeted level of assets necessary for the plan sponsor to maintain fully funded status. Thus, the pension liability has bond-like features including an inverse relationship to interest rate movements. Therefore, aligning the duration of assets with the duration of liabilities simultaneously aligns the market risk with the accounting risk of the plan.
  • This is the very reason why 2008 was so devastating: stocks fell and bond yields dropped precipitously. Lesson learned. Focusing on the firm’s guaranteed liability will better enable the firm to meet both current and future liability payments.

New premium rules from the Pension Benefit Guarantee Corporation (PBGC) further incentivize plans to drift toward LDI policies.

  • Some background is in order. The PBGC administers the pension plan termination insurance program covering almost all DB plans maintained by employers in the private sector. It collects two types of premiums: a flat-rate premium assessed per participant, and a variable-rate premium based on the plan’s funded status.
  • The Budget Act of 2013 signed into law increases for both types of premiums this year with further increases in every year through 2017. Plans clearly have an incentive to try to both reduce the number of participants in the plan, as well as to avoid risks that could push the fund back into deeper under-funded status.

The actions of private DB plan sponsors are, therefore, only modestly driven by their role as a fiduciary who tries to maximize return per unit of risk. On the contrary, the private DB fund manager’s decisions are based more by regulatory incentives and funding status than by return predictability.

  • A few notable DB plan failures (e.g. Delta) resulted in the Pension Protection Act (PPA) which became fully enforceable in 2011. The aim of the PPA was to ensure strict oversight, larger required annual contributions, and penalties for plans that carry an unfunded liability (particularly below the 70% threshold). All ERISA and rule violations are extremely expensive.

The major factor behind the improvement in funding status has been the Fed’s QE policy, hich has fueled great increases in asset prices. Now that the QE program is being unwound, it is only prudent for these pension sponsors to position assets that mirror more closely the movement of the liabilities; especially as the premium formulas discourage risk.

Given the decline in market liquidity and so many investors chasing the same crowded riskseeking trades, these pension flows could have a material impact on market prices for the remainder of the year. Currently, most portfolios remain over-weight equities and high yield and underweight Treasuries and short duration. However, I expect portfolios to reconsider these weightings. With this in mind, and due to factors outlined in notes earlier this week, I remain bullish on long-dated Treasury securities.

 

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Tue, 04/22/2014 - 20:42 | 4684906 CrashisOptimistic
CrashisOptimistic's picture

1) Pension funds outsource management so they aren't making these decisions

2) No one is selling stocks and buying bonds.  Only machines buy or sell stocks.  The bonds are outright bought by elderly people and they probably didn't have money in stocks to begin with, and won't.

3) The PBGC information is interesting

Tue, 04/22/2014 - 20:54 | 4684951 Greenskeeper_Carl
Greenskeeper_Carl's picture

because 'smart' people are going to go into bonds, since loaning money to bankrupt institutions is a safe place to put your money

Tue, 04/22/2014 - 20:54 | 4684958 Pladizow
Pladizow's picture

I call bullshit on this article. The pensions are grossly underfunded and require an 8% return - there will be no rotation!

Tue, 04/22/2014 - 21:05 | 4684997 fonzannoon
fonzannoon's picture

I hear you. I would call bullshit too but I notice he focused on corporate pensions and not federal pensions which require the Madoff return. Those pensions will continue to raise taxes to cover those gaps.

Tue, 04/22/2014 - 21:21 | 4685044 Pladizow
Pladizow's picture

Yep, but where is there more money?

Wed, 04/23/2014 - 00:12 | 4685462 Schmuck Raker
Schmuck Raker's picture

Got a mirror?

Wed, 04/23/2014 - 10:01 | 4686294 SoilMyselfRotten
SoilMyselfRotten's picture

They are trying to line up the muppets for dismemberment

Tue, 04/22/2014 - 21:33 | 4685089 disabledvet
disabledvet's picture

third thumb up on both these comments. i'm staying with the treasury bet both from a technical point of view (all time record highs two years ago, sell off when i put the bid in a year ago January, immediate positive impact, big time sell off but nothing that changed fundamentally relative to the trade, nice recovery off the panic selling last summer going into the year) and from a still speculative view that we're full on mid cycle correction territory (profound damage by the Fed not telegraphing their move higher in rates this summer, a huge surge in natural gas prices this (never ending) winter, Suddenly Putin, etc...etc).

I have said from the Getco (tm) that this was not a position that i wanted to see actually make money because it had/still has VERY negative implications...both for me personally (i would much rather have a booming economy to get to work in like we had in the 80's) and because the position making money has very bad implications. (epic fail of the ACA, a war no one wants, needs, desires..though folks in DC may THINK they want it.)

of all the people on Planet Peon to extol the virtues of rationality I think I would be the last one to be that person...but i am still "soldiering away" in this regard.

War with Russia is CRAZY TALK.
It scares me to death...and I hope by my own "crazy talk" it puts some thinking into the folks who have the profound responsibility to make perhaps the most historic of decisions...probably since the Civil War actually.

So "all kidding aside" here...but I hope people realize I "joke around" for a reason. Once this thing goes hot...there is no way of going back...and all of us...not just here in the USA but perhaps a big chunk of the world...will find itself at the mercy of events.

Then you'll see me "shut it down."

I have the utmost respect for Secretary of State Kerry, the Veep, and of course the Commander in Chief...but this is at one stroke a very complicated situation with an incredible number of moving parts yet in the same breath an incredibly simple yet totally terrifying "decisive moment."

"that's why they get paid the big bucks" (not) as they say.

to say i have my strong opinions and i present them strongly would be an understatement of course...but there is a point of no return here.

Explaining this to the American people...especially outside the ZH "universe" will come as a shock to them.

"And this is just the Europe part."

Next week is "Asia week" actually...which at WB has so directly expressed "appears even more stark and terrifying" actually.

Quantam of Solace indeed.
http://www.youtube.com/watch?v=yfYC_CBNtiM

Tue, 04/22/2014 - 20:56 | 4684964 AreaMan
Tue, 04/22/2014 - 20:46 | 4684917 ebworthen
ebworthen's picture

Well, the smart people are getting the fuck out of the casino stock markets.

Problem being they get paid shit for investing in bonds, all by design.

PONZI!

Tue, 04/22/2014 - 20:47 | 4684919 I Write Code
I Write Code's picture

Remember, if (and when) inflation spikes, anyone holding conventional bonds is going to be devastated.

In light of that, and reality, anyone who shifts to bonds now, while the long bond pays under 4%, is insane.

Tue, 04/22/2014 - 20:50 | 4684937 CrashisOptimistic
CrashisOptimistic's picture

Of course, those insane folks are up 15% YTD.

Wed, 04/23/2014 - 01:58 | 4685602 I Write Code
I Write Code's picture

It just may be a lunatic you're looking for!

Been a crazy six years so far ...

So is this really the New Fed Handout, they "spike" rates to 3.9, the "smart" money buys, then QE takes rates back down to 2.6 and pockets a 30% gain?  And who is buying down there but the fed?  OMG.  Do we really think they're gonna do that again as at the end of 2012?  How do I get on the email list for this?

Tue, 04/22/2014 - 23:35 | 4685400 Flakmeister
Flakmeister's picture

Inflation will not spike, it ends with the bond market in effect going bidless...

And with it, trillions will evaporate.....

And that doesn't happen as long as oil is primarily transacted in USD....

We have anywhere from 10 to 20 years unless the House of Saud falls first....  

Wed, 04/23/2014 - 03:29 | 4685678 SDShack
SDShack's picture

The bond market won't go bidless if the bankers have their way. The Fed already controls about 1/3 of the bond market, and that has completely distorted it. Imagine what will happen when the Fed controls 51% of the bond market. It's game over then. The ponzi becomes self-sustaining when the Fed controls the bond market and the printing press. The Fed will essentially take over the Federal Govt at that point and Debt Monetization will be the new currency. It's the ONLY plan the bankers have left. Hell, we are probably almost at this point already when you factor in all the World Central Banks colluding together to control the bond market. China sells Treasuries, and Belgium buys them. It's happening all around you every day. Start thinking like a sociopathic banker if you want to know where the world is going. The bond market isn't going bidless now. Why would it go bidless when the Central Banks control 51% of it? We are rapidly approaching NWO shit. 

Tue, 04/22/2014 - 20:48 | 4684925 dutchTender
dutchTender's picture

this picture is so awesome ..... need cheese puffs

Tue, 04/22/2014 - 20:49 | 4684931 devo
devo's picture

Hot potato! I'm a spuud man.

Tue, 04/22/2014 - 20:50 | 4684935 fonzannoon
fonzannoon's picture

"There are around $16 trillion in corporate pension assets in the US of which approximately 43% are DB plans. Many of these plans were materially underfunded (more liabilities than assets) after the 2008 crises. However, after years of QE and resulting asset price inflation, a large portion of these funds have returned to near fully-funded status (97% levels on average according to most estimates). Russell Investment analysis shows an improvement of almost 15% in 2013 alone."

That is pretty astonishing, if true.

Anyway, I asked this question the other day, but if you are a pension fund manager, would you rather lock yourself into UST's with a 2.7% yield or buy something like MLP's (just one example) that yield 6% plus with some growth potential? Treasuries are for Belgium.

Tue, 04/22/2014 - 20:52 | 4684947 CrashisOptimistic
CrashisOptimistic's picture

Well, they are for Belgium and the Fed, who have apparently bid them up 15% this year.

OTOH, MLPs are all about pipelines, and it shouldn't be long until scarcity this winter causes them to get themselves nationalized.

Tue, 04/22/2014 - 23:38 | 4685404 Flakmeister
Flakmeister's picture

I see any such nationalization....

But this is the year that Shale gas is supposed to show what it is for real. NG stocks are at historic lows...

http://ir.eia.gov/ngs/ngs.html

Be sure to check out the first figure, 50% below the 5 year minimum....

Tue, 04/22/2014 - 21:03 | 4684993 NoDebt
NoDebt's picture

Fonz- you have mail (or shortly will when I'm done typing it).

Tue, 04/22/2014 - 21:30 | 4685077 Dapper Dan
Dapper Dan's picture

speaking of Belgium

From http://fofoa.blogspot.com/

 

A number of people have emailed me asking for my thoughts on Belgium's recent "buying spree" in USG securities. Here is one of the emails:

 

"What do you make of the treasury buying out of Belgium? Seems like maybe someone isn’t yet ready for the transition? Really curious to see who it is."

 

 

I don't know who it is, but I thought I'd explain which part of the data that I like to watch. Two years ago I used the term "willy-nilly support" to contrast what was happening at that time with the "structural support" of previous decades. Here's a quote from that post:

"In fact, even though it is true that some combination of Japan, oil exporters, Caribbean banking center, Taiwan, Switzerland, Russia, Luxembourg, Belgium and Ireland (to name a few) managed to cobble together the necessary support last year, the dollar is now living off of a willy-nilly support system rather than the "structural support" it enjoyed for the last 30 or so years."

This Belgian buying smells worse than "willy-nilly support" to me. What I watch is the "structural support", defined as the storage of homeless dollars in central banks around the world. Here is FOA from 10/5/01:

read the rest @

http://fofoa.blogspot.com/

Tue, 04/22/2014 - 20:54 | 4684953 dutchTender
dutchTender's picture

doesn't this make the case the fed did help the avg joe??? last time i checked, billionares don't need pension plans

Tue, 04/22/2014 - 21:08 | 4685008 fonzannoon
fonzannoon's picture

"doesn't this make the case the fed did help the avg joe???"

Ssshhh. we only speak in absolutes on here. Also, no questions allowed. 

Wed, 04/23/2014 - 07:39 | 4685945 Watchingtheweasels
Watchingtheweasels's picture

Average Joe was driving to the jobsite where he works the other day in his 1998 F150 with 200,000 miles on it when the transmission gave out.  AAMCO quoted him 3000 for a new transmission.  So he did some truck shopping and realized that at a sticker price well north of 40,000 he is never going to buy a new truck.  With gas permanently above 3.50 a gallon he couldn't afford to fill it up anyway.  So average Joe rode his bicycle to work Monday.  Ate some egg rolls and rice for lunch...

Yep, the Federal Reserve has certainly helped out Average Joe...

Tue, 04/22/2014 - 20:55 | 4684954 Yen Cross
Yen Cross's picture

  So supposedly the 2.60% area in the 10 year is where the longs start covering and taking profits... This lemming wants to buy into the longer end of the bond market with rates moving higher from inflation fears and profit taking?

 Scratching head with deer antler...

Tue, 04/22/2014 - 21:14 | 4685028 CrashisOptimistic
CrashisOptimistic's picture

Most of this shit doesn't mean anything, but like wages that don't rise with all forms of inflation, neither do bonds fall with all forms of inflation.

If you see a future with higher bond yields, you are saying you see a future with vibrant economic growth -- because that would be the engine of that inflation.

Food inflation and gasoline inflation don't do that.  Why?

Because they do not denote increased demand in borrowing.  Only economic growth does that.  Boom the economy and people line up to borrow money to expand blah blah blah.  Debt is like other items of supply and demand.  Demand more of it and the price (yield) goes up.

Demand none, or little, and the price of that debt (yield) falls.

Bond buyers and owners see poor economic growth.  And that's that.

Tue, 04/22/2014 - 22:05 | 4685140 tom a taxpayer
tom a taxpayer's picture

CO - Thank you for the many enlightening posts!

And your post here about food and gasoline inflation vs economic growth vs bond yields is a huge eye-opener for folks like me.

Tue, 04/22/2014 - 22:12 | 4685183 Yen Cross
Yen Cross's picture

  Crash I agree with most of your comment. However you can have inflation through devaluation, which is what I'm talking about. As the usd falls out of favor rates will move higher in order to get traders to buy bonds. That will be inflationary. Look at Zimbabwe , Venezuela, South Africa, Turkey as examples. Their economies aren't high demand or growth, yet they have skyrocketing rates from devaluation.

Tue, 04/22/2014 - 20:56 | 4684965 Gringo Viejo
Gringo Viejo's picture

Bonds! James Bonds!
Fuck me in the ass if you can...shaken....not stirred.

Tue, 04/22/2014 - 21:03 | 4684991 logicalman
logicalman's picture

Paper promises are worth ..........??

Tue, 04/22/2014 - 21:10 | 4685015 CrashisOptimistic
CrashisOptimistic's picture

They are worth more paper, which is how you pay for food right now and for the forseeable future.

Tue, 04/22/2014 - 21:28 | 4685054 cowdiddly
cowdiddly's picture

correction." how you pay for food right now". sorry but there are 47 million that use another form plus maybe a few million like myself that get their lazy arse out of bed each day and produce their own. just sayin.....

Tue, 04/22/2014 - 21:07 | 4685006 stant
stant's picture

Corporate bonds maybe big maybe

Tue, 04/22/2014 - 21:22 | 4685047 The Capitalist ...
The Capitalist Review's picture

Even good analysts fall trap to this fallacy.  John Hussman has blown up this fallacious notion of "asset class rotation".  There is no such thing as moving out of "x" and into "y".  The only differentiating factor is price - the price to which you are willing to hold an asset.  All assets created, whether stocks, bonds or cash exisit until retired.  Someone that sells equities to "get into" fixed income, simply swaps the asset, the only difference is the price.  At some point, there will be no greater fools willing to trade their zero-yielding cash for equities at current prices.  That's not a "rotation out of equities and into cash" the assets still exisit in the same quantities, but the expected return based on current prices is not enticing enough to make the trade. 

Tue, 04/22/2014 - 21:36 | 4685096 Perimetr
Perimetr's picture

"Needless to say, the Fed, which is doing everything in its power to push marginal buyers out of a bond purchasing decision and instead to chase Ponzi risk into equities, will not be happy, especially since QE is tapering"

Hahahaha

as they say here in the midwest, this feller got it Bass Ackwards

The last play of this game is to siphon ALL available (and unavailable) funds into the black hole of the bond market.

Then POOF!!!! It all turns to shit as the petrodollar dies and the global reserve currency becomes gold-backed Yuan and Ruble

Tue, 04/22/2014 - 22:19 | 4685195 Downtoolong
Downtoolong's picture

the upside for a firm with a fully-funded plan is less rewarding than for an under-funded plan.

...i.e., Now that we've gambled and won we might want to think about not gambling anymore, especially when the bet is on an investment in FaBookAmazaGoogaTweeTesla shares with an expected return of <2% already priced in and the notion that "Asset prices just have to keep rising Lenny, because, well shit, they just have to."

 

 

Wed, 04/23/2014 - 00:34 | 4685492 Spungo
Spungo's picture

I don't always rotate my portfolio, but when I do, I put it into bonds that have negative interest and offer absolutely no protection against the impending tsunami of inflation caused by QE.

Wed, 04/23/2014 - 13:49 | 4687219 Black Warrior W...
Black Warrior Waterdog's picture

Stay liquid, my friends.

Wed, 04/23/2014 - 08:10 | 4686013 22winmag
22winmag's picture

I'm constantly rotating from food to fuel to ammo to PMs.

 

When the charades and musical chairs come to a screeching halt, just know that you could have converted that paper into wood or kerosene to keep warm this coming winter.

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