The recent backup in interest rates is signalling that the long awaited "great rotation" from bonds to stocks is well underway. This was confirmed this week by the largest flow of funds into stocks since June of 2008 i.e. right before Lehman. At that time, bonds were enduring a short-lived sell off as well...
Good Timing:
It only took four years to get investors onboard with the U.S. rally. Note how fund flows into Emerging Markets (EM) have been rising all along, even though those markets have been underperforming since 2011:
Fund Flows Are a Contrarian Indicator:
U.S. stocks (red) rose even as fund flows were negative until this year. Emerging markets (blue) went nowhere since 2011 even as flows of funds rose. Note the recent a-b-c retracement on the emerging markets chart...
Where Did All The Revenue Go? To China...
By selling bonds and buying stocks, investors have increased the yield on bonds (interest rates) and reduced the (earnings) yield on stocks. This at a time when revenues on stocks are beginning to decline as we saw this week with Coca-Cola, GE, Ebay, Google, Microsoft and Intel. Across the board, revenues have been declining for two quarters now. However earnings have been sustained through stock buybacks funded with cheap financing. The backup in interest rates now raises the cost of funding for companies which will make buybacks more expensive going forward. From an asset class perspective higher interest rates also make bonds relatively more attractive. So one asset class is going vertical while its yield is going down, and another asset class is going down while its yield is going up. We also learned this week that after five years, "Wall Street's most badass investors are done fighting the Fed" aka. capitulated. And GDP estimates were cut in half this week from 2% to 1% for the most recent quarter due to weak retail sales.
The short-lived interest rate rise back in 2008:
Given that GDP is stalling, hence deflationary, there is no fundamental reason why interest rates should be going up, other than a temporary asset allocation due to the fact that stocks have been outperforming bonds for a long time now i.e. a million investment advisors can't be wrong, can they?
So, as it was in 2008, interest rates will rise until something big breaks or until the stock market rolls over, or most likely both...
Municipal Bonds not as sanguine about the Detroit bankruptcy as the Dow Jones is:
So, as it was in 2008, interest rates will rise until something big breaks or until the stock market rolls over, or most likely both...
Municipal Bonds not as sanguine about the Detroit bankruptcy as the Dow Jones is:
