The Economist's Buttonwood speculates today on whether 2013 will be the year of the "Great Rotation," from bonds to equities. The prognosis is interesting, and Buttonwood examines three scenarios, given that rapid U.S. economic growth is absent, the potential outcomes are limited to "inflate, stagnate, or default."
Here's what Buttonwood said:
• To many, it seems obvious that the long-term returns from government bonds will be dismal, in real and nominal terms, so stocks are the asset to buy. The relative valuation of equities looks good; the dividend yield in many markets is higher than government bond yields, something that was common in the first half of the 20th century, but has been rare since then.
• Stagnation has been the path followed by Japan, and as a result the "great rotation" has never happened in Tokyo; government bonds have stayed low and equity markets are still only a quarter of their peak. Japan has the advantage of owing the money to its own citizens, so it has not faced the same external pressure as Greece.
• the US has the great advantage of issuing debt, not just in its own currency but in the global reserve currency for which there is massive investor demand. It can impose "financial repression" on investors by paying a yield on its bonds that is negative in real terms. It also has the Federal Reserve, which has shown a willingness to buy large numbers of Treasury bonds, to keep yields down.
• Default is unlikely (but not impossible) for countries that issue debt in their own currency.
• What does this mean for equities? Any assumption that short rates will be at very low levels for extended periods must be based on a parallel assumption that growth will be sluggish.
• So while we may well see fund flows move in the direction of the equity market, it seems hard to believe we will see a massive asset reallocation.
• A mini-rotation is more likely.
Source: The Economist, January 9, 2013
