The “Great Rotation” Myth: An Update

What’s the secret to being right a lot?

According to Jeff Bezos, Founder of Amazon.com (AMZN), it’s simple: Be willing to change your mind.

He’s observed that the smartest people constantly revise their understanding, reconsider points of view and evaluate new information – even if it’s contradictory.

On such merits, today I’m going to try to be “right” a little more…

Bailing on Bonds
Back in May, you’ll recall I blew gaping holes in the notion that a “Great Rotation” – out of bonds and into stocks – was underway.

At that time, investors were definitely getting friskier with stocks. But they were funding their purchases with cash that had been parked in savings accounts, not by selling bonds. Bond fund flows were still positive.

What a difference 10 weeks makes, though.

Blame it on the Fed for freaking everyone out about a taper, or investors being slow to spot opportunities. It doesn’t matter. What’s clear is that investors are bailing on bonds in droves…

From June 1 to July 10, investors yanked $74.9 billion out of bond mutual funds, according to the Investment Company Institute (ICI).

Data from TrimTabs, which is a bit more extensive, validates the exodus, too. It shows that investors pulled $79.7 billion out of bond funds and ETFs over the same period.

The latest research from Goldman Sachs (GS) also indicates that the rotation is underway. (What can I say? I’m stubborn like that and insist on multiple sources to confirm that a change is afoot.)

The firm’s “Rotation Index” hit its highest level since late 2008, which means that retail investors “have a higher risk appetite and bias towards equity funds,” says strategist David Kostin.

Goldman estimates that the average retail investor now has 69% of their assets invested in equity funds (domestic and international). That’s up from 65% in 2012.

Here’s the key, though. Not all of the money being yanked out of bonds is going directly into stocks. Far from it.

Based on TrimTabs data, only about 25% of the money, or $20.8 billion, rotated out of bonds into stocks.

So where did the rest go? Under the mattress. Over the last six weeks, TrimTabs and Federal Reserve data show that bank savings deposits increased by at least $75 billion.

Bottom line: The highly anticipated “Great Rotation” is definitely underway. However, investors appear reluctant to go straight from bonds into stocks. Instead, they’re taking a pit stop along the way in cash.

That being said, it’s only a matter of time before it all ends up in the stock market. So does that mean it’s time for us to identify the nearest exit? After all, the average retail investor is notoriously terrible at timing the market. Historically, they buy in right before market tops and sell out right before market bottoms. I’ll save that discussion for tomorrow’s column. Stay tuned.

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