In a strange turn of events, we are witnessing one of the biggest reversals in recent memory. Unlike 2013, which was labelled the ‘great rotation’ due to the dramatic shift from fixed income into equities amid the taper tantrum, 2016 is marking the ‘great reversal’ as equity outflows gain momentum.
History has shown investors add strongly during bull markets and withdraw during market crises
What is most interesting about this trend is that it has coincided with a strong rally in equity markets, unlike previous equity withdrawals in 2008 or 2011/12. This is very unusual investor behaviour, although possibly a rational response, as history has shown a tendency for investors to add strongly to their positions during bull markets and withdraw during market crises. To illustrate the point, the chart below shows that a “bull market sell-off” has not occurred on this level at any other time in the past 10-years.
The two questions that naturally stem from such a phenomenon is why investors are fleeing the markets and where this money is going. While there is no definitive answer to the former, the latter seems more obvious. Resulting from the drastic equities sell-off, flows to fixed income markets have markedly spiked once again in 2016, with $201 billion in inflows.
As is depicted overleaf, this now ascribes a cumulative net inflow into fixed income of over $2.3 trillion since the global financial crisis; equating to an enormous pot of money in what we would describe as expensive assets.
On this occasion the spike in fixed income coincides with a time when the global government bond index has a yield of just 0.65%, nearing an all-time low. It also comes at a time when the U.S. appears likely to announce an interest rate hike, directly opposing the reason behind the 2013 ‘taper tantrum’ sell-off in fixed income. Yet most intriguingly, when looked at on a relative basis, the preference for fixed income over equities has hit an alarming level. As depicted below, net flows have hit their greatest six-monthly variance since the global financial crisis and show little sign of deteriorating in the near-term.
What is Driving this Dislocation?
We have known about the equity outflow problem for many months, with much of the negative sentiment coming from Europe in the midst of growing contagion risk and a reluctance to accept lower yields. This continues to be a driver - with net withdrawals exceeding those experienced in the eurocrisis – and could be expected to remain so as investors are clearly increasing bond allocations ahead of the Italian referendum and Brexit negotiations.
This is most easily explained as a fear response. Investors inherently struggle to deal with uncertainty and this leads to a shift into ‘safe-haven’ assets or assets with obvious growth prospects. In the current environment, this has driven investors towards a relative overweight position in fixed income and emerging-market equities. To disclaim our perspective, we have been bullish on emerging markets for a while and have been pleased to see the market coming around to our view.
