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Eight graphs: a great rotation from one overpriced asset to another
by David Campbell on Aug 08, 2013 at 12:12
Fund flows from bonds to equity now appear overwhelming - but are investors trading one baked-in loss for another?
Equity inflows (as measured by the US Investment Company Institute) mirrored bond fund outflows almost exactly in July, prompting us to ask last week if the much rumoured, little evidenced Great Rotation between the asset classes was finally underway.
A question which data issued by BlackRock’s Exchange Traded Product research team appeared to answer with a definitive ‘Yes. Next question’. Total passive equity investment in July increased faster than at any time since the beginning of 2010
Admittedly this was accompanied by a slight recovery in fixed income flows after the stampede of May/June
But delving into the details shows that bond flows were solely supported by a wave of money into short duration vehicles with little or negative rate correlation. More mainstream bonds are still experiencing redemptions, just at a slower pace than before
We also previously asked a secondary question: are investors trading one set of built-in loss making for another? That appears more valid than ever: in the last two months more than £30 billion has flooded into US equities – a bit more than 80% of all the capital committed to equity globally.
While there is plenty of room to argue whether or not US equity is fairly valued or not, we could probably all agree that it is not cheap. At the end of July the S&P 500 was trading at 19.27 times 12 month trailing earnings, almost exactly at its 40-year average
More long term measures of equity valuation such as Shiller’s cyclically adjusted PE which attempts to average out long term price to earnings over the economic cycle, were looking peakier, at 24.69, versus a long-term average of 19.47.
A point made by GMO in a recent note considering the internal rate of historical returns of a cross section of asset classes at current valuation. On GMO’s numbers this would appear just about the worst time to jump into a broad US equity position with both large and small cap US equity trading at a price historically consistent with a negative annual return. Only a ‘quality’ stock style bias above water.