Is It "The Great Rotation" Or "Bad Behavior"
There has been a significant number of articles written since the beginning of this year pronouncing that the "Great Rotation" of money from bonds into equities has finally arrived. Most recently, my colleague Josh Brown, posted a note stating:
"My argument was a very simple one...Capital does not chase value, it follows performance, and stocks had been winning for too long to continue to escape notice. Once the bonds started looking shaky, it had become a fait accompli.
The debates had tapered off by late spring and now the evidence has become undeniable. It took a few relevant periods (one-year, six-months, etc) of stock vs bond outperformance to do the trick, but Americans are back to investing for their futures again. It's a shame they're coming in so late, but this is the nature of the beast."
The reality, unfortunately for most investors, is summed up best by the last part of Josh's statement. It is much more likely that the current "rotation" of money from stocks into bonds is more likely a continuation of the bad investment behavior by retail investors rather than a secular shift in sentiment.
Retail investor's actions are driven by emotion rather than logic. The chart below shows the investor psychology cycle of investment behavior overlaid against the S&P 500 index. The bar graph in the chart is the 3-month average of net monthly inflows by retail investors into equity based mutual funds. (Note: the data provided by ICI only goes back to 2007, however, I wanted to include the previous market cycle for comparative purposes.) Not surprisingly, net equity inflows have turned positive at the peak of the market in 2011, just prior to the debt ceiling debate debacle, and the current QE driven asset inflation.
As I recently discussed in "Is This A 2007 Redux" the similarities in the current market environment, and the 2007 peak, are surprisingly similar from the perspective of leverage, earnings and economic growth. We can now add investor behavior to that list.
Tyler Durden at Zero Hedge recently posted the following which further supports my concern:
"Much has been made of the inflows into US equity markets in the last few weeks with the heralding of The Great Rotation that will lift us to Dow 36,000 and beyond. The only problem...is that, as BofAML notes, institutional investors have never (that's a long time) sold as much stock as they have in the last 4 weeks - as retail has been piling in.
On a four-week average basis, net sales by the Institutional clients group are the largest in our data history (since 2008). Private clients have been net buyers of US stocks on a four-week average basis since early June. Private clients' net buying streak is currently their longest since late 2011.
So it would appear the 'real' great rotation is passing the hot-potato of liquidity-driven stocks from the 'smart' money to the 'dumb' money once again."
I very much agree with this sentiment. As article after article is written chastising investors for not "jumping into the market" the psychological "fear" of being "missing out" is dragging the remaining retail holdouts back into the market.
The reality is that we have witnessed this same behavior by retail investors time and time again the outcome of which has never been good. Despite words of advice from some of the great investors of our time that the road to investment success is paved by knowing when to:
- "buy low and sell high"
- "cut losers short and let winners run," or;
- "buy fear and sell greed"
retail investors repeatedly do the opposite. As markets rise, and reach extreme levels of exuberance, it is only then that retail investors believe it is time to jump in. Unfortunately, as shown by the BofAML study, much of that belief is driven by the self-serving interests of the Wall Street community that profits the most from retail investors emotionally driven decisions.
When will we ever learn?