Great Rotation? No, The Reverse

According to many market watchers, 2014 was supposed to be the year of the so-called Great Rotation out of bonds and into stocks. However, as I write in my new weekly commentary, we’re actually seeing the reverse happen lately, though I believe the case for stocks is still quite strong

Weekly flow figures for the week ended May 7th show that investors sold more than $9 billion worth of equity funds and poured more than $9 billion into bonds funds, with nearly $3 billion flowing into U.S. Treasury Exchange Traded Products (ETPs). Though corporate earnings have remained solid andeconomic data have been pointing to an improving economy, investors have been rotating out of stocks and into bonds.

As has been the case for some time, the selling is most acute among last year’s leaders — the growth and momentum areas of the market. In a continuation of the pattern that has been in place for several weeks now, investors are moving away from smaller-capitalization stocks and growth styles and into large caps and value stocks.

While the stock market is enduring a spate of selling, the opposite is occurring in fixed income markets. Investors are still pouring money into bond funds, helping to keep yields stubbornly low. Several factors appear to be behind this. First, although equity markets are mostly ignoring the events in Ukraine, risk aversion is helping to drive assets into Treasuries. By BlackRock’s analysis, geopolitical risk is shaving approximately 0.25% off of yields.

Additionally, Federal Reserve actions and statements are helping to keep yields low. Last week, Fed Chair Janet Yellen highlighted concerns over the housing market, which investors took as an indication that the central bank was committed to keeping policy easy given the still-present fragility in the economy.

But despite the selling, I still believe that stocks offer better value than bonds. Within the equity market, however, I continue to advocate embracing some of last year’s losers and adopting a general bias toward value-oriented areas of the market, like large and mega cap names.

That said, as more investors move into relatively safer areas of the stock market, some of the defensive sectors, including health care, consumer staples and utilities, are starting to look richly valued. In particular, I’d suggest trimming positions in U.S. utilities stocks, which look expensive and are vulnerable to the gradual rise in interest rates that I expect to happen over the second half of this year.


Sources: Bloomberg, BlackRock research, Citi Research

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