Is The "Great Rotation" Finally Appearing?

Bond prices fall (and long-term interest rates start to rise)

Now that government bonds have been falling for a number of months (with bond yields rising inversely to the falling price), as global economic growth prospects have steadily improved, and also as investors grow increasingly nervous of any change in monetary policy from the US Federal Reserve, potentially slowing the rate at which they currently buy US government bonds (under their Quantitative Easing program) from the US government. 

1. Euro, US government bonds have lost over 5% since April this year

Up to now, the Fed has successfully helped to drive long-term interest rates both in the US and indeed worldwide to new historic lows, in their attempt to support growth in the US economy. However, now all the talk in financial markets over the last couple of months has been about a shift in monetary policy towards "tapering", i.e. not buying quite as many US bonds as they have done up to now, in an effort to begin weaning the US economy off the "easy money" drugs before it becomes too much of a permanent habit. 

US investors take note, respond by pulling money out of bond funds

US retail investors have responded to this expectation of slight change in US Fed policy by selling bond funds in size. 

2. Finally, retail investors start to sell bond funds

Interestingly, the same retail investors have tended to put money into equity funds, chasing the upwards momentum in US and foreign stock markets. 

3. But they continue to put money into equity funds

As economist Ed Yardeni comments: 

"over the past 13 weeks through the week of August 28, the Investment Company Institute estimates that bond funds had net cash outflows totaling $438 billion at an annual rate. Over the same period, equity funds had net cash inflows of $92 billion at an annual rate. I wouldn’t describe that as a “Great Rotation” just yet, but it could be the start of a big swing by retail investors into equities."

Ed Yardeni - Great Rotation?

What does my Multi-Asset Trending System (MATS) have to say?

My proprietary multi-asset trending system, that chooses between equities, bonds and cash once per month in a number of different regions, is invested 60% in equities (UK small-caps, Euro low volatility, Japanese currency hedged shares) and 40% in cash. Note: 0% is invested this month in government bonds, highlighting the poor trend in bond market performance over the past few months. 

Why listen to this systematic (i.e. the asset classes are chosen using a simple mathematical model rather than by yours truly!) investment approach? Because it has gained over 15% net of trading costs in the year to date, that's why! 

The Main Risk: That there is more to come out of bonds, into equities

Judging by ETF flows over 2013 to date, the risk is that this reversal in flows in bonds funds could turn from a trickle into a flood: looking at global bond (fixed income) Exchange-Traded Fund (ETF) flows, this year to date has still been positive to the tune of nearly $19bn, on top of strong positive inflows over 2010-2012. 

Source: BlackRock4. Bond ETF flows have been strongly positive since 2010.

Conclusion: Equity Income Funds look set to attract bond refugees

We can see from the following chart that UK investors have also been putting greater amounts of cash into equity unit trusts this year, while flows into bond funds have been, in contrast, stagnant. 

5. UK retail investors putting increasing amounts into equities too...

My personal theory is that retail investors will look to replace the income generated by their bond funds with equity income funds instead; i.e. that they will buy funds focused on good dividend-paying names in the UK and Continental Europe. 

6. UK Dividend Aristocrats ETF surges upwards

One of my personal favourite ways to buy into solid dividend-paying names without taking too much risk is via the SPDR UK Dividend Aristocrats ETF (UKDV). This ETF focuses on dividend-paying companies in the UK that have managed to raise their dividend consistently each year over at least the past 10 years. As a result of this dependability, this group of dividend payers have the happy side-property of having on average lower volatility (i.e. less risky) than for the overall market. On top of that, it is also an easy way to buy into the outperformance of value strategies over the long-term.

If you want to be more sporty with your investment, then I would look at a portfolio of UK mid-cap and small-cap companies that have not only raised their dividend consistently over the past few years, but that offer a decent dividend yield (over 3%, thus much better than government bonds or cash rates) combined with strong price momentum. 

You might want to look at: Sports Direct (SPD), Tribal Group (TRB), Chesnara (CSN), Aviva (AV), James Latham (LTHM) and ICAP (IAP) as good examples of stocks that fit this description. 

Good luck with your investments,
Edmund

Back to School! What a relief! Japan, Small-Caps still motoring ahead

Back at the beginning of August, I noted how a number of clear investment trends were still in evidence, most notably:

1. The outperformance of Small-Cap companies in the UK, Continental Europe and US;
2. The stock market recovery in Japan following a sharp sell-off;
3. The outperformance of the European Retail sector (largely supermarkets) versus the broad market.

Now post the Back-to-School period, where do we stand on these three trends?

1. Small-Caps: Still Breaking New Highs

UK, European and US small-cap indices continue to break new year highs, in the process outperforming benchmark indices in the various regions:

UK Small-Cap ETF Still Hitting New Highs, Beating FTSE 100 hands down

Given the strong rebound in economic indicators such as manufacturing confidence indices, I believe that this small-cap outperformance trend still has legs, and so I remain happily invested principally in UK small-cap companies like Tribal Group (TRB), Inland Homes (INL) and Sepura (SEPU).

2. Japanese stock market boosted by GDP growth, 2020 OIympic Games

The Japanese stock market story also remains intact, boosted by a surprisingly strong 3.8% GDP growth print for Q3 2013, and the awarding of the 2020 Olympic Games to Tokyo. 

Nikkei Index Maintains Health Lead Over MSCI World Index

Again, I remain firmly committed to the Japanese equity market story, and keep my MSCI Japan (GBP hedged) ETF (IJPH) for now.

3. Retailers Better Other Defensive Sectors, Overall Stock Market

And thirdly, the back-to-school period has led to healthy gains for the European Retail sector, most notably from supermarkets that tend to benefit from a boost in sales of school clothing and the required stationery for the new school year. In the process, retailers have left not only overall stock market indices for dead, but also other defensive sectors like Food & Beverages (see below). 

European Retail Far Outstrips the Defensive Food & Beverage sector

I remain a fan of a number of Retail stocks in the UK as a way of playing this bullish trend, including Sports Direct (SPD), Marks & Spencer (MKS) and Dixons (DXNS).

In the next posts, I will have a look at a number of new themes and trends, but for now, stick with these three good'uns. 

For now, as the French say, Bonne Rentrée (literally, "good back to school")!

Edmund