Any Coming Rotation Won't Be So Great

by: Roger Nusbaum

Mark Hulbert posted an article that was skeptical of what is being referred to as the great rotation. The great rotation is the supposed shift from fixed income to equities because many boomers are believed to be underweight equities. So if/when this happens it would lead to much higher equity prices.

Hulbert says ni to this idea. As he puts it "all stocks and bonds currently are owned by someone. There is - by definition - no under- or over-ownership." This is an oversimplification in my opinion and distorts quite a few real world factors.

All stocks are owned by someone but someone can include inventories of professional market participants whose job it is to provide liquidity, not actual investors. Further, if two investors currently own no equities and decide on the same day to go back in and coincidentally decide to buy the same stocks and funds, then depending on the circumstance they may be in competition for the current inside offer.

If our two investors want to buy 1000 shares Transatlantic Zeppelin (one of the stocks in Montgomery Burns' portfolio) then there is buying demand for 2000 shares. If the current offer is $25.41 and is good for 1000 shares only, then one of our two investors will get that 1000 shares offered at $25.41 and the second investor will either need to pay a higher price or wait until another seller is willing to sell at $25.41 and of course no one may be willing to sell at that level ever again (the risk of using a limit order instead of a market order, of course market orders have risks too).

If a lot of cash comes into equities, great rotation or not, then demand will likely exceed supply and prices will go up (not a prediction, just basic economics). Such an increase could persist for an extended period or not but the argument that the great rotation can't matter because every share is already owned is simply incomplete.

The better question is whether this will matter. If the great rotation does occur it will simply be a positive catalyst for equities but will not ensure equities go higher. At any given time there are a series of positives and negatives for stocks. You may conclude the great rotation is meaningful and then you will either be right or wrong just like anything else.

As far as my take on this I tend to believe that demographically driven flows of capital can move markets for an extended time however I don't think that is what is in store for stocks, that is to say I don't think there will be a great rotation resulting in a 1990s-like rally stemming from investors rotating out of fixed income in the manner Hulbert is referring to.

The Great Depression drove some segment of the stock-buying public away forever and I believe that has also been the case with the Great Recession too (more precisely the 2000s). I believe some portion of the investing public fled stocks, was willing to go into bonds and if they get punished in the bond market then the next stop for them is the mattress (metaphorically speaking).

That is not to say that stocks can't go up, just that any rotation won't be so great.

[FYI Barron's is free this weekend.]