We haven’t talked much about the stock market over the last year or so because the short term fluctuations are largely irrelevant. You should be investing regularly in low cost mutual funds and have an asset allocation appropriate for your risk profile.
But every once in awhile a story comes along with enough merit to talk about it here. And the idea that a large shift in asset allocation could change the balance of stocks and bonds for the next ten years is a big enough idea. A theory has emerged that a “Great Rotation” is about to (or has already started) happen. This rotation is huge movement of money that’s been sitting in bonds into stocks. As you can see from the chart, money has been leaving the stock market in droves and into bonds (cash and other stuff too).
Who has been moving all their money though? It’s a combination of most every type of investor out there. Retail investors and retirement savers got scared by the stock market’s fallout due to the financial crisis. Institutional investors like pensions, insurance companies, and hedge funds all got scared too. Many opted for the safety of bonds which provide a fixed return. Even if that return is very low, it’s not negative like stocks can be. Believers of this Great Rotation of money back into stocks think all these investors are going make the switch soon.
That’s largely due to what will happen to fixed income investments over the next few years. Bonds offer a fixed return, but their values will fluctuate based on the demand for a bond. It can be sold at a discount or premium. Aside from demand for bonds, the underlying interest rates can also influence value. Everything today is offering a very low interest rate. Rates will soon start to increase and then investors will dump their bonds. Like a hot potato, you don’t want to be the last one holding a bond paying out 1% interest when the going rate is now 5%.
The Great Rotation implies that stock values will go soaring over the next few years just based on demand alone. This idea contrasts with my own theory that retiring baby boomers will move more assets to bonds over the next 10 years. But my theory hasn’t exactly been tested yet and I’m literally not banking on it. But like I said up top, none of this should really concern most of you. So long as you have a portfolio set up the way you like and you rebalance once or twice a year then just sit back and watch the ride wherever it takes us.
CITI: All This Talk About A ‘Great Rotation’ In 2013 Is Bunk (Business Insider)