Thoughts on the Great Rotation

Reports indicating that Americans have invested more in equity funds here in 2013 than they did all last year have given rise to talk of the "Great Rotation".  The idea is that Americans are selling fixed income investments bought during the financial crisis and now buying shares.  

We are less sanguine.  There is a third asset class that needs to be integrated into the analysis:  cash.  After surveying the data and various reports, it looks to us that the flows into equities is not coming out of fixed income but rather money market funds and deposits.  

At the end of last year, perhaps spooked by the pending fiscal cliff and policy paralysis, many investors boosted cash (money market and deposits) holdings.  One estimate had cash holdings rising by about $350 bln in the Nov-Dec period and about $165 bln has flowed out since the start of the year.  

Through last week, equity funds (counting ETFs) saw an inflow of around $70 bln (compared with $23 bln in all of 2012).  The $30 bln inflows being reported by bond funds is a major argument against the "Great Rotation", though this is a bit off the pace seen last year ($40 bln inflows during the same period).  

Drilling down a bit deeper may offer greater insight into what investor are doing.  Of the $70 bln that went into equity funds (and ETFs), about 40% went international/global funds, which is more than half they took in all last year.  Among bonds, about 40% also went to emerging markets, which is roughly tracking last year's record pace. 

Lipper reported that in the week ending Feb 6, equity funds (mutual funds and ETFs) saw $6.1 bln in new inflows.  It was the seventh consecutive week of inflows.  Of this sum, $2 bln as in ETFs.  However, Lipper notes that the SPDR S&P 500 ETF fell from top position the previous week to last on the back of $3 bln of redemptions.  The iShares Russell 2000 index was on top with $700 mln inflow, followed by ishares Dow Jones Real Estate ETF, which took in $600 mln.  

Traditional open-ended equity mutual funds saw inflows of $4.1 bln.  According to Lipper data, the 5-week inflow of almost $25 bln is the largest inflow for such a period since the beginning of Q2 2000.  Domestic funds, led by large cap, drew $1.1 bln.  Global and international funds reported inflows of $3.1 bln.  Emerging market funds saw $1.8 bln inflows.  Lipper notes this was the fifth consecutive week that emerging market funds drew more than $1 bln. 

Many Asian bourses have reported strong inflows (greater than last year) thus far this year.  In terms of the biggest gain from the year ago period, investors have bought almost $1.1 bln of Indonesian shares, which represents.  In terms of dollar amount, Japan of course is the largest bourse and in play, given the yen's weakness.  Foreigners have bought about $14.1 bln of Japanese shares this year, which is 135% above the year ago pace.  India is also a large beneficiary of foreign purchases.  The $7.6 bln that has flows in represents a 725 increase from a year ago.  

On the other side, South Korea is a significant exception.  Foreign investors have sold about $1.5 bln of Korean equities.  The appreciation of the won against the yen appears to have contributed to the profit-taking.  Taiwan and Thailand have seen inflows ($1.6 bln and $22 mln respectively), but are well off last year's pace. 

That said, we note that the Korea's Kospi appears to have bottomed at the second half of last week.  The 2.5% bounce has brought it to a trend line drawn off the Jan 3 and Jan 23 highs.    The next target is near 1985 (closed near 1976 today). Longer-term, a recovery could see 2040-2050.   The technical condition looks favorable as the RSI has turned higher and the MACDs are crossing.