Why Investors Are Fleeing Both the Bond and Stock Markets

By Michael Lombardi, MBA for Profit Confidential

Late last year, the concept of the “Great Rotation” became popular. The idea behind the Great Rotation was simple: the theory was that once the bond prices started to decline, investors would take their money out of bonds and put them into the equity markets.

The logic behind the Great Rotation made sense. When one asset class becomes too risky, the bond market in this case, investors usually run towards other assets. But the Great Rotation isn’t happening?

Yes, the bond market has certainly come down from its peak. If we look at the 30-year U.S. bonds as an indicator of the bond market, the yields on those bonds are up roughly 24% since the beginning of the year. The 10-year U.S. notes are in a similar situation, if not worse. It’s the biggest bloodbath for the bond market we’ve seen in years.

But investors are not fleeing the bond market for the equity markets. In fact, we are seeing the opposite. Investors are leaving both the bond market and equity market.

The chart below illustrates the inflows/outflows from U.S. long-term bonds and stock mutual funds.

While the chart above shows data from January to June of this year, in July, if you add the weekly outflow from the bonds mutual funds, they were upwards of $16.0 billion. In August, for the three weeks ended August 21, the long-term bonds mutual funds had an outflow of a little more than $17.0 billion. (Source: Investment Company Institute, August 29, 2013.)
If investors are not going to the equity markets as they run away from the bond market, where are they parking their money? Turns out they are seeking safety, moving to the sidelines.
Money market funds assets are increasing in value. According to the Investment Company Institute, assets of all money market funds hit $2.64 trillion on August 28, 2013. (Source: Investment Company Institute, August 29, 2013.)
With investors moving to the sidelines, it suggests they are uncertain about the direction of equities and are waiting to see how the situation plays out. Stock market investors should pay close attention to this outflow of capital. It’s Economics 101: markets do not rise when capital flows out of the markets.
Michael’s Personal Notes:
After the financial crisis, companies in the U.S. economy were able to show robust growth in their corporate earnings; they were able to sell their products and services to where the demand was outside the U.S., to the global economy.
Unfortunately, the tides are turning. The global economy is showing signs of weakness. Pick up a map, and point a finger to any general region of the global economy; chances are that countries there are struggling with demand, and they are revising their growth rates downward.
Companies in the U.S. economy are very reliant on what happens in the global economy. Consider this: in 2012, companies on the S&P 500 that provided figures about global sales reported that 46.6% of all their sales came from outside the U.S. economy. (Source: S&P Dow Jones Indices, August 2013.) Yes, nearly half of the sales these companies generate come from the global economy.
It doesn’t take much to see the global economy is slowing, not growing…
Take a look at the European Union—one of the biggest economic hubs worldwide. New passenger car registrations in the region were down 6.6% in the first six months of this year compared to the same period a year ago. (Source: European Automobile Manufacturers’ Association, July 16, 2013.) Europe is in trouble; American companies will have trouble growing their corporate earnings in that region.
The Chinese economy, the second-biggest economic hub in the global economy, is also slowing. A significant number of U.S. companies do business there. For 2013, the Chinese economy is on track to grow at its slowest pace in years, as problems persist in China, including risks such as the shadow banking sector, skyrocketing home prices, and slowing exports.
In the second quarter, we witnessed first-hand how fragile U.S. corporate earnings were. If we take out the financial companies from the S&P 500, the corporate earnings growth rate for the second quarter of 2013 was borderline negative.
With the global economy on the fringes, it will be even more difficult for companies to boost corporate earnings in the third quarter. Looks like the stock market itself is finally coming to that realization.
What He Said:
“I personally expect the next couple of years to be terrible for U.S. housing sales, foreclosures, and the construction market. These events will dampen the U.S. economic picture significantly in the months ahead, leading to the recession I am predicting for the U.S. economy later this year.” Michael Lombardi in Profit Confidential, August 23, 2007. Michael was one of the first to predict a U.S. recession, long before Wall Street analysts and economists even thought it a possibility.