So much for the Great Rotation.
In case you forgot, 2013 was supposed to be the year that investors pulled their money out of the bond market and put it back to work in equities.
Given that all bond mutual funds have seen net cash inflows of about a trillion dollars since 2009, this rotation out of fixed income and into stocks was supposed to deflate — if not burst — the alleged bond bubble once and for all.
But it ain’t happening, at least not yet.
And a world of weak economic growth, low inflation and seriously frayed market nerves makes it look more unlikely than ever.
Just have a look at Tuesday’s intraday action when the AP’s Twitter account was hacked. A fake tweet said a bomb went off at the White House, injuring the president.
How did the market react?
- Stocks plunged, with the Dow Jones Industrial Average gapping down 150 points in seconds.
- Gold — the safe-haven asset that isn’t — barely budged.
- Treasury prices? They soared.
The yield on the benchmark 10-year Treasury note — which moves in the opposite direction of price — hit an air pocket on that fake tweet. The CBOE 10-year Treasury note index cratered to an intraday low of 1.64% — a mid-session level last seen in December.
Make no mistake: When the market freaks out, it rushes into the warm embrace of U.S. government debt. Not only is the Treasury market the biggest and most liquid in the world — making it big enough to hold all those panic-stricken refugees from other asset classes — but after gold’s freefall of late, it looks to be the last safe haven standing.
The thing about Treasury debt is that it all but eliminates one of the three big risks that holders of fixed income have to worry about.
Inflation kills bondholders because it erodes real returns. A rise in interest rates clobbers them because it causes bond prices to fall.
But the biggest risk for bondholders is default — of not getting your regular interest payments or the return of your principal. And when it comes to Treasury debt, the risk of default is about as low as you can get without being nil.
After all, the federal government has a massive tax base and a printing press to make good on its obligations. Equally important, in the U.S. system, the banks and securities firms designated as primary dealers are required to bid on federal government debt. By design, Treasury auctions cannot fail. (Another reason why the U.S. is not Greece.)
That’s why when a Wall Street investment bank blows up or there’s an earthquake-tsunami-nuclear disaster in Japan (or a Twitter account gets hacked), Treasury prices spike and yields fall.
Which is another reason why the case for the Great Rotation even beyond Tuesday’s panic doesn’t look so strong these days: The yield on the 10-year note closed as high as 2.06% as recently as early March. Now it’s down to 1.7%. Treasury prices are going up, not down.
Mutual fund flows don’t back up the Great Rotation meme, either. Domestic and international stock mutual funds have had estimated net cash inflows of $67.5 billion so far this year, according to the Investment Company Institute. Meanwhile, taxable and municipal bond funds have seen even greater inflows, adding a net of $72.2 billion.
Money has been flowing into stocks and bonds — not one asset class at the expense of the other.
The knee-jerk reaction to that fake tweet showed how sensitive the market remains to outside shocks. Sure, the news was fake, but the trade was real — and it showed the market’s shaky hand.
A wholesale rotation out of debt and into equities seems unlikely as long as the market’s appetite for risk can turn into nausea at the speed of a tweet.
And when it does, it vomits up stocks.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.