Great Capital Migration, Not Great Rotation

Includes: SPY
by: Mark Thomas

At we are always fascinated by the intersection of the professionals who work on Wall Street and the Financial Press. Late in 2012 and early in 2013 many financial professional pundits who make a living dealing in equities claimed that 2013 would be the year of the Great Rotation. This was a scenario where investors in bond funds would feel the singe of losses because of higher interest rates and finally sell their bond funds and put those funds back into stocks. So far it hasn't quite worked out that way because bond yields did rise in the first quarter but they subsequently fell back again.

Over $60 billion in new money has come into equities reversing six years of net withdraws but those funds mainly came from cash and a return of individual investors, according to Trim Tabs. It was one of the best examples of how people who desire a certain outcome that would benefit them personally and their industry, were kind of wishing out loud in hopes if they just repeated it enough, it would come true. It was especially hilarious how they changed the name of "the Great Recession" to "the Great Rotation" because the great recession was enabled and amplified by Wall Street.

However there is an additional factor that has come into play in 2013, which was not predicted and it is significant, the Great Migration of money from overseas into the United States. This began when the U.S. dollar finally bottomed out at the beginning of February. The weakening dollar makes investing in U.S. assets less attractive because of the effects of the currency depreciation in a foreign investor's net total return. Then events in Cyprus reminded Europeans especially that their money really isn't safe anywhere on the continent, even in insured deposits in banks. The rest of the world now believes with some good reasons that the U.S. and its rule of law is probably the safest country in which to place their investments. Then Japan embarked on a massive money printing expansion of its monetary base, basically signaling to its own citizens and foreigners to borrow in their currency and speculate outside of Japan to avoid the falling currency. This year U.S. stocks have been marching steadily higher, real estate and even bonds have remained strong. It is my opinion that foreign investors have been a factor leading the increase in asset prices.

The key to the Great Rotation theory that many who were proponents of forgot was that the holders of bonds and bond funds need to experience some pain and actual losses before they give up that perceived safety. Stock investors also forget that almost all bond investors right now, because they purchased bonds when interest rates were higher, are sitting on capital gains in their positions. Many also are earning higher yields than the bonds currently pay if they were purchase today. Only when the Federal Reserve ends its manipulation of interest rates and or the markets themselves send rates materially higher, will there be a significant rotation from bonds back to stocks. Now of course if stocks continue to outperform bonds like in the first months of 2013 that will naturally attract back investors who might change their asset allocation and return to stocks.

Now as the author of a newsletter focusing on the short-term swing trading of stocks, nothing would please me more than more individual investors returning to the stock market. However there are some benefits to the current market where institutions and hedge funds dominate the market. Over the years, I have found it easier to have better relative performance in stocks when the public is not heavily involved in individual stocks. I find it easier to get an advantage and outperform large investors because they are all trained similarly. They tend to be bound by group think and their size limits their flexibility and nimbleness. That is why when I trade I try to focus on the smaller of the large-cap stocks. I especially favor and focus on mid caps. Mid-cap stocks trade more like large caps but have more market information inefficiencies similar to small-cap stocks. Also by being more liquid mid caps are less volatile than small caps, while still offering potential profits in excess of large-cap stocks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.