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How to play the great rotation....using currencies

by Sarah Miloudi on Feb 12, 2013 at 09:01

A record $77.4 billion crashed into equity funds in January as the great rotation kicked off, but the wave of investors rushing from bonds into stocks might want to stop and think.

The switch from bonds into equities is something investors have been eyeing for a while - going as far back as February 2012 the likes of Stewart Cowley were sounding warnings over government debt, and with the FTSE 100, now above 6,200, clinging on to much of its gains, investors still looking to allocate to equities will be hard pushed to find a cheap deal.

The situation could not be more different over in the currency markets, where the great rotation coincided with the beginning of a cyclical bull market and a return to fundamentals.

But a few weeks after money started pouring into stocks, US employment data and the eurozone budget talks blocked the uplift enjoyed by equities from spilling over into forex.

Disappointing this may be for investors early to the party, but for the remainder, this safeguarded the opportunity to play the mother of all allocation shifts through currencies.

As Deutsche Bank's George Saravelos points out, the move away from bonds to equities has as much to do with currencies as stocks, even if its impact is harder to spot.

Saravelos believes that in the early stages of the rotation, investors should look for the euro to outperform. This would follow three years of flows into safe haven currencies, and backing up his view, figures from the US Commodities Futures Trade Commission showed net euro longs last week hit a 19-month high.

Secondly, Saravelos argued FX drivers should become less 'idiosyncratic', so essentially, investors should feel that policy changes and their own allocations are dictated to a greater extent by individual country fundamentals rather than bigger and broader macro risks.

To some extent, this shift is already underway because correlations between FX and investors' risk appetite have fallen, but at the other end of the spectrum, some investors still have to be sold on the idea of an immediate great rotation, even if they do acknowledge the potential to trade such a move using currencies.

'We think equities are going to do well but do not necessarily expect to see a sell off in bonds,' said Investec's Thanos Papasavvas, a fixed income and currencies strategist.

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