Channeling Stocks

[JLS]

The “Great Rotation” from Bonds to Stocks

While traveling last week, I kept hearing stock brokers ask: “What are my fixed income clients going to say when they receive their June monthly statements?” Due to the sudden surge in Treasury yields in the past two months, bond investors have had a truly horrific few weeks watching their principal erode due to 10-year Treasury bond yield rising from 1.66% on May 1 to an intraday peak of 2.67% last week, before settling back to 2.52%.

In response, PIMCO’s Bill Gross and five Fed Presidents were out and about last week telling investors that Fed Chairman Ben Bernanke’s recent comments were “misinterpreted,” and that bond investors have grossly “overreacted.” For instance, New York Fed President William Dudley said last week that any expectations of imminent rate hikes are “quite out of sync” with the FOMC’s official statements and the expectations of most FOMC participants. Still, bond investors withdrew $23.7 billion from taxable bond funds in the past four weeks. Additionally, foreign central banks sold $32.4 billion in Treasury debt last week, the largest weekly redemption ever and the third net weekly withdrawal in the past four weeks.

Bond yields have settled a bit in recent days, but the damage has been done. Fixed income investors seem to be realizing that bonds are not an oasis of safety when their principal erodes so rapidly. The last time I can remember seeing such a sudden spike in bond yields was 1994, when 10-year Treasury rates rose from 5.6% in January to over 8% in November. That sparked an impressive stock market rally in 1995.

The strong recovery in stocks since last Tuesday suggests that this bull market remains healthy and resilient. The stock market could become the new oasis for conservative investors, just like it did back in 1995. So far, the market gains of 2013 rival the start of the big market surge in 1995. Now, as then, the bull market was already 4+ years old – starting in late 1990 – but the biggest gains were yet to come.

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