Avoid getting in a spin about the great rotation

AS THE equity markets surge onwards, many are calling the beginning of the great rotation – the point when retail investors finally rotate out of the perceived safety of cash and bonds, and back into the stock market.

Talk of the great rotation has occasionally made it into analyst notes over the last couple of years. And as the Dow toys with the 14,000 mark, it is now being talked about with increasing frequency. But though January saw net bond outflows, and net inflows into equity funds, the great rotation may be overhyped. While institutional investors may be more mobile, it is difficult to say that retail investors are leaving the safety of bonds and cash, and dipping their toes back into the riskier stock market.

Last month saw the strongest one month equity run since the height of the dot com bubble. But much of this strength can be explained by cheap money being pumped into the markets by the Federal Reserve, to the tune of $84bn (£53bn) each month. While this stimulus will likely continue to prop up the equity bull market, it is not enough to say that retail investors are returning en masse.

With fixed income markets offering very little in the way of return, and cash offering near-zero interest rates, investors looking to go further along the risk curve in exchange for higher returns would usually pile into equities. While the blistering pace of the stock markets bears witness to the fact that this has been happening at an institutional level, it has yet to do so at a retail level.

“The further away we get from the last crisis, the more likely we are to see retail investors return,” says Brad Sorensen, director of market and sector analysis at Charles Schwab. But the last crisis wasn’t long ago. Retail investors who returned after the huge wealth destruction of 2007-2008 were given a spooking by the flash crash in 2010. “The flash crash shook a lot of confidence, just as investors were beginning to come back. If another event like that happens, we will have to wait a long time for investors to feel safe again,” says Sorensen.

US ambassador to London Joseph Kennedy famously quipped of the end of the 1920s bull stock market: “I knew it was time to sell when my shoeshine boy gave me a stock tip.” There may well be an element of Kennedy’s shoe shine boy in the current markets – particularly when two of the hottest single stock picks in the market in 2012 – Facebook and Apple – wiped out billions in personal wealth.

The great rotation may be a handy story for stock brokers trying to coax clients back into the market, but whether it will turn into a reality is yet to be seen.