Most articles arguing for a short-to-medium term bull market in equities point to the catalyst provided by the rotation of capital out of bonds (and cash equivalents) and into equities. This seems logical, as yield-starved investors are beginning to emerge from their nuclear fallout shelters. However, there may be a different rotation in the horizon that could prove even more influential. This is the rotation of investment capital out of low yielding developed countries (US) and into high yielding EM countries.
Recently many authors on this site, and the WSJ (article here), have noticed a sizable decline in US business investment. In the third quarter of 2012, investment in software and equipment stalled for the first time since early 2009 in the face of a sluggish economy and political uncertainty. While many may argue that domestic investment will rebound as soon as Washington gets out of the way, the graph below from the World Bank is quite interesting. It plots the path of US net private capital flows (net FDI + net portfolio flows) since 2003. As one would expect, it shows large capital outflows following the 2008 crisis, and then the repatriation of capital as the US started its slow recovery in 2009. However, what catches the eye is the sudden reversal of the trend, leading to a net capital outflow in 2011. Data for 2012 has not yet been released.
Providing more context, the chart below, using data from the US Department of Commerce, shows that US direct investment abroad reached a historical high in 2011.
While this trend is not definitive it does seem logical. Large US institutional investors and multi-nationals are looking to deploy their investment capital in high yielding EM countries, versus the current low yielding domestic environment. As Jim O'Neill has argued, corporations and investors that fail to focus (at least partially) on the emerging consumer will probably miss the boat in this coming decade and beyond.
Should capital continue to flow overseas, it will have long-term effects in the US. Large US multi-nationals (and their shareholders) that take advantage of foreign opportunities will prosper, but the resulting vacuum in domestic investment will surely prove a major headwind for long-term economic growth in the US.
Perhaps the rotation long-term investors should be watching is not between bonds and equities, but between the US and abroad.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.