Bonds shine again as Great Rotation gives way to Asset Reflation

Investors may have simply realised the pace of last year’s stock market rally was unsustainable and so decided to buy more bonds

Traders work on the floor of the New York Stock Exchange shortly after the opening bell on Wednesday. Photograph: Lucas Jackson/Reuters

Traders work on the floor of the New York Stock Exchange shortly after the opening bell on Wednesday. Photograph: Lucas Jackson/Reuters

Fri, Apr 18, 2014, 01:25

Last week, morning investors queued around the block to buy the bonds of recent defaulter Greece, and by the end of the day were selling US tech stocks furiously.

In an investment world so used to the concept of “risk on” or “risk off” over recent turbulent years, the behaviour was puzzling. So what happened?

Observers point to a combination of three drivers – stocks valued too highly, global growth failing to meet expectations and underlying investor behaviour since the turn of the year – but curiously no single catalyst.

Many stock markets around the world, including those in both developed and emerging countries, are at or near their highest levels ever, thanks to central banks propping up the global economic recovery with their ultra-loose monetary policy.

In the United States, the S&P 500 has almost tripled its level since the post-crash trough in March 2009, while the Nasdaq Composite index weighted more towards technology stocks has gained almost 250 per cent in that time.

This meant that at the end of March, US stocks were the third most expensive in the world behind Japan and Mexico, analysts at Barclays estimate.

In its latest monthly poll of global fund managers, Bank of America-Merrill Lynch said the proportion of investors who think stocks are “overvalued” is now the highest since July 2000, just when the Nasdaq was in the early stages of collapse.

So perhaps a correction was on the cards. Assuming that to be true, the readjustment was most likely to be seen in stocks most sensitive to the second driver, a reappraisal of global growth expectations.

And that’s exactly what happened. Last Thursday’s 3 per cent slide in the Nasdaq was its biggest since November 2011.

Two days before that, the International Monetary Fund trimmed its 2014 world growth forecast to 3.6 per cent, the fifth downward revision from its last six projections, and OPEC lowered its 2014 forecast for oil demand, traditionally a closely-watched barometer of global economic activity.

“I’m not sure what the trigger was, but the market moves do suggest that investors are lowering their sights on growth and expect rates to stay low for longer. Hence equities down and bonds up,” said Joachim Fels, chief international economist with Morgan Stanley.

Rotate to reflate
The asset class that benefits most in this environment is fixed income, especially euro zone bonds if the European Central Bank pulls out all the stops in its fight against deflation, potentially keeping interest rates super-low for years to come.

Demand for Greece’s five-year bond, which marked Athens’ return to the bond market only two years after defaulting, topped €20 billion. More than 500 investors bid for them.

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