Whatever happened to the “Great Rotation?†You remember the predictive theory that ultra-low yields would encourage investors to rotate out of bonds and into stocks. The notion picked up steam shortly after the Federal Reserve announced its intention to taper its quantitative easing (QE) program in May of 2013. Yield-sensitive assets of all stripes — corporate bonds, Treasury bonds, munis, preferred shares, REITs — experienced the type of rapid wealth destruction that is more commonly associated with significant stock slumps. Meanwhile, U.S. stocks weathered the initial uncertainty, rallying throughout the remainder of the year.
Granted, one asset type may appear to curry favor at the expense of another asset type. That certainly seemed to be the case when bonds experienced their first negative return in two decades; it certainly appeared to be a reasonable conclusion when the S&P 500 logged a monster annual return of 30%. However, it is impossible to determine if capital outflow from bonds actually became additional inflow for stocks. For one thing, the disappearance of bond wealth does not require a corresponding move into equities; bond prices can fall independently. What’s more, since there is a buyer for every seller of all stocks and all bonds, if one group of investors has rotated from bonds into stocks, another group of investors would need to represent the other side of shift. What crowd, then, represented the other faction that abandoned stocks for the low-yielding bond world?
I am not suggesting that money does not flow in and out of perceived value. I am merely uncovering the reality that an opposite (and equivalent) grouping must exist as well. Which is the dumb money — the bond buyers at historically low yields or the stock buyers at historically high price-to-earnings (P/E) ratios? Or maybe the smart money is shifting into undervalued emerging market securities.
Regardless of where you stand on the rotation debate, the price gains and losses for a variety of ETF types in 2014 may surprise you. Why? Because last year’s winners have had a rough go of it lately. In contrast, last year’s losers have been basking in a warm glow of ascendancy.
