The ‘Great Rotation’ is a silly, nonsensical investment trend

Have you heard about the “Great Rotation” of investor money out of bonds and into stocks? Google it and you will come up with thousands, if not millions, of hits. According to the Great Rotation theory, investors will eventually tire of (or no longer accept) the low yields in the bond markets and rotate their investments to stocks.

The concept was originated by a brokerage firm. It has become a media darling. It’s very catchy and simple — perfect ingredients to inspire reaction. Brokerage firms and the media profit when concepts that are catchy lead to transactions. 

The concept implies that investors will be better served by owning stocks instead of bonds. This concept is silly for many obvious reasons. Let’s briefly review the issues and get you focused back on what matters.

First of all, you simply cannot have investors exit bonds and buy stocks in disequilibrium. There is ALWAYS a buyer and a seller in the public markets. If someone sells a bond, there will be a buyer. If someone buys a stock, there will be a seller. There is a limited supply of stocks and bonds, and there is always a buyer and seller. It is why we call them “markets”! So the whole concept of “rotating” out of one and into the other is mathematically impossible. 

Secondly, if one believes that quantitative easing has influenced historically low bond rates (which I personally believe it has) then one must understand that QE has also influenced all riskier assets through the bidding up of investment value.

All investments base their value on a premium to the risk-free investment, which in the U.S. and most of the developed world we consider the Treasury bond. If bond yields fall, other investment assets rise because investors look for other investments to get similar returns, thus bidding them up in price.

They take on additional risks by doing this, though. If bond yields rise, there is a natural arbitrage for investors to grab the new higher yield, and they do this by selling other investments (usually stocks or other types of bonds) to get this new investment yield. Those other investments usually fall in value. Because bonds are more stable in yield and more reliable in return (albeit often a much lower return), bonds adjust less than stocks. In other words, if we see a massive rise in interest rates, not only will bonds suffer, but stocks will suffer more. There is no free lunch. 

Finally, the worst potential impact of following the Great Rotation is that investors will start chasing returns: buying high and selling low. Wall Street profits when investors react emotionally. The Great Rotation inspires this epic turning point in the market where if you don’t “rotate” you’ll be left behind.

News flash: Stocks have been on a tear for four years now. If you haven’t been a long-term investor in stocks in at least part of your portfolio, you missed a lot already. Bull markets don’t go on forever. Four years after it leaves the terminal is generally not a good time to start chasing the train. 

(Continued)

Bonds and stocks have their own attributes that make them both worth owning. Bonds can stabilize a portfolio from equity risk. Bonds can offer a fixed yield. Bonds behave differently than stocks. Stocks generally reward long-term investors for taking on greater risks — though risk means one could lose money. Stocks have a greater potential for loss than bonds. A mix of both is generally considered a mark of a prudent long-term portfolio for good reason.

Don’t let the Great Rotation inspire you to make a reactive move. Be smart. Make a plan. Understand that plan is something you do for the long term and is specific to your needs. Understand there’s no free lunch. Ignore contrived concepts like the Great Rotation. It’s pure silliness, and you work way too hard to let silly ideas dictate your investment policy.

 Michael Dubis is a fee-only certified financial planner and president of Michael A. Dubis Financial Planning, LLC. He is also an adjunct lecturer at the University of Wisconsin Business School James A. Graaskamp Center for Real Estate. Mike can be reached at financialperspectives@gmail.com.

 This article contains the opinions of the author. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products or services described in this website or that of the author’s. Mike Dubis does not guarantee the relevancy, appropriateness, or accuracy of any outside information or links. Mike Dubis does not render or offer to render personalized investment advice or financial planning advice through this medium. All references that might be made to an investment or portfolio's performance are based on historical data and one should not assume that this performance will continue in the future.
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