ING IM – First strike in the Great Rotation is for Europe
The two most important themes influencing our asset allocation stance are currently the strengthening of the global business cycle – led by developed economies – and the gradual normalization in allocation tilts of large money managers.
Both are clearly in favour of equities. With regard to the latter, we see that the exposure to equities continues to increase with year-to-date flows into equity funds by far outpace those into other asset classes. Initially, mainly excessively high cash levels were used to increase allocations towards equities however for the past few months there has been an increasing move from bonds into equities. Ben Bernanke's 'taper talk', with rising bond yields as a result, was for many investors the green light to start tapering their bond portfolio. The 'Great Rotation', which was a big theme in the headlines at the beginning of this year, now finally seems to get underway.
Yet we do not expect investors to massively sell their bond holdings. Structural influences, such as the ageing society which implies an increasing demand for income generating assets, and regulation which forces institutional investors to hold a substantial bond portfolio, are too powerful for such a sell-off.
However, we think that the rotation from bonds to equities is only just underway. Since the start of this century, we have seen an enormous flight into fixed income assets with a combination of financial crises (the burst of the IT bubble, accountancy scandals, the credit crunch and the sovereign debt crisis) and regulatory changes having 'forced' institutional money managers to shift allocations from equities into fixed income. The gradual decline in 10-year bond yields – already since the '80s of the last century – was a strong tailwind for bond investors in that respect. The tsunami of liquidity that has been injected into the financial system by central banks was the catalyst for the final act of the rate decline. And this trend now finally seems to be turning.
Despite the Fed's decision not to taper its asset purchases evidence of an acceleration in global growth is getting stronger. An improvement in macro-economic data was visible in Japan and the US from May onwards, a few months later followed by the UK and the Eurozone. Since August we also see increasing signs of emerging markets starting to profit from an upturn in demand from developed markets.
Apart from the upward effect on bond yields from an acceleration and broadening of the economic recovery, it is also a strong tailwind for equities and a new phase in the bull market seems to have begun. Higher economic growth, combined with modest margin improvement, will contribute to a pick-up in earnings growth which will be most obvious in European and Japanese corporate earnings. Europe has the added advantage of a decrease in the systemic risk perception of investors together with being significantly undervalued meaning that the first strike in the Great Rotation therefore seems to be for Europe.