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The Great Rotation: a 12-point history lesson dating back to 1705
Bank of America Merrill Lynch is among the biggest advocates of the 'Great Rotation' from bonds into equities. In this 12-chart history lesson dating back to 1705 it adds some colour to its thinking.
UK base rate since 1705
‘In 300 years of history, the Bank of England's base rate has never been lower than the 0.5% of the past 4 years (Chart - note new BoE Governor Carney wants to keep it there for a few more years).
‘The degree of policy stimulus and intervention in global financial markets is historically unprecedented and has been and continues to be extremely positive for asset prices. But in the next year, the ability or otherwise of policy makers to finally deliver above-trend economic growth in the US, UK, Europe and Japan will determine the fate of asset prices.’
Gold price since 1920
‘The dramatic rise in gold prices in the past decade is testament to a unique period of financial market history. The decline in gold prices in the past 18 months indicates investors are discounting the beginning of a stronger economic recovery after a period dominated by deflation, debt deleveraging and default risk following the Great Financial Crisis.’
The US Dollar since 1967
‘The US economy is leading the recovery and spurred by massive monetary stimulus, the end of fiscal austerity and a booming housing market should accelerate sufficiently in coming quarters to achieve 'escape velocity'. Policy success and reduced dependence on QE would be best signaled by a strong appreciation of the US dollar allowing the trade-weighted US dollar index to rise from 81 today back to its long-term average of 100. ’
US government bonds since 1936
‘2013 is likely to mark the end of a 30-year bull market in bonds. An era of abnormally strong fixed income returns is now under attack from the end of the 'new normal' and the ongoing 'Great Rotation'. The 10-year annualized return from long-term US government bonds has already dropped to 6.8%, and is likely to remain on a secular downtrend.’
US equities since 1936
‘Meanwhile the 10-year annualized return from US large cap stocks is currently 7.6%, up dramatically from the negative returns recorded in 2009. Indeed, long-run equity returns are now beating fixed income returns, despite the widespread 'fear' of stocks and 'greed' in bonds over the past decade.’
History of US equity bull markets
‘That said, secular equity bulls must concede that the current S&P500 bull market is 'mature' both in terms of duration (52 months versus an average of 56) and return (149% versus an average of 163%). History does not suggest significant upside to US stock indices from current levels, especially given the absence of a meaningful correction in the past 18 months.’
US financials since 1990
‘The ability of a mature and pricier US bull market to continue now becomes more dependent on the financial sector, which in contrast to many other US sectors is currently not at an all-time high. The US financial sector is roughly 45% below its all-time high set in Feb’07.
‘We continue to view the bank stocks as the best barometer of the Great Rotation. Rising bank stocks and rising rates is bullish; rising rates and falling bank stocks is bearish. With the former more in evidence in recent quarters, we are willing to give stocks the benefit of doubt.’
Europe v US in price terms since 1989
‘European stock prices remain close to their lowest levels relative to US stocks in 25 years (Chart). Now that European bond yields have collapsed, current account surpluses are appearing all over the Mediterranean and property prices are attracting a bid, we expect the secular underperformance of European equities to reverse.’
The depreciation of Japan since 1988
‘Japan is another stock market at the end of a secular derating: in 1988 Japan’s equity market was the largest in the world, with a market cap that represented 44% of the MSCI All Country World Index; by late 2012 that share had collapsed to an all-time low of 7%.
‘Policy makers are finally working to reverse this long-term trend with aggressive asset price inflation. Success in reflating the land market in Japan is now crucial to equity prospects in the next year or two.’
GEMS and Asia Pacific since 1988
‘In contrast, the global share of Emerging Markets and Asia Pacific is on the decline from almost 20% of world markets to 16% today. Slower Chinese growth, the revival of domestic demand in the West and large current account deficits across EM suggest this is set to continue unless...’
GEM bond yields since 1950
‘... the secular bull case for emerging markets now rests solely on the ability of interest rates to fall over the medium term. The historic collapse in rates across EM in the past decade was a key factor behind the secular bull market. Politicians must reestablish fiscal discipline and retreat from intervention in the real economy if EM rates are to decline again and maintain capital inflows into consumer and financial sectors.’
Projected population growth from 2000-2099
‘Secular population trends still favour Emerging Markets, as working population growth in Asia, Latin America, the Middle East and Africa will easily outpace growth in the West. Demographic trends in Africa are of particular note with the population of Nigeria set to overtake that of Indonesia’s by 2034, and the US population in 2045.’