Let’s start with some definitions from the dictionary. “Chump change” is a small or insignificant amount of money. “Chunk of change” is a lot of money. Equity mutual funds have attracted chump change since the start of the current equity bull market. A large chunk of change has been going into bond mutual funds instead. At the same time, the amount of liquid assets held in savings deposits has been soaring to new record highs.
Since Election Day, there is some evidence that “Trump change” is reviving animal spirits among business executives, purchasing managers, and consumers. At least that was the initial response to Trump’s victory. The stock market also responded favorably, with the S&P 500 up 8.3% since Election Day (Fig. 1). Bond holders, on the other hand, experienced capital losses as the yield rose 53bps to 2.41% since Election Day (Fig. 2).
Since late 2014, there has been much chatter about a “Great Rotation” out of bonds and into stocks. It was deemed to be the only way that the stock market could continue to make new highs once the Fed had terminated its QE program and started raising interest rates.
Perma-bears had been tracking the close correlation between the S&P 500 and the assets held by the Fed (Fig. 3). They argued that but for the Fed’s ultra-easy and unconventional QE monetary policies, the bull market would have ended long ago. My response to that amazing insight was: “So what’s their point?”
Lo and behold, the Fed terminated its QE program on October 29, 2014. The FOMC hiked the federal funds rate by 25bps on December 16, 2015 and again on December 14, 2016 to a range of 0.50%-0.75%. The futures market has priced in an increase to 1.16% within the next 12 months (Fig. 4). Yet the S&P 500 is up 16.8% since QE was terminated!
Joe and I observed that rising earnings were also driving the bull market, not just the fumes from the Fed’s QE (Fig. 5). Another significant driver of the bull market, which we spotted early on, was the huge inflows of corporate cash through stock buybacks and dividend payouts. Together, they’ve totaled $5.5 trillion from Q1-2009 through Q3-2016 (Fig. 6). That’s likely to continue to drive the market higher, particularly if “Trump change” includes the repatriation of some significant portion of the $2.5 trillion that US corporations have parked overseas.
There is some preliminary evidence that investors may finally be starting to rotate out of bonds and into stocks. Debbie and I aren’t rooting for a Great Rotation, since that might push bond yields up to levels that pose a threat to the economy and the bull market in stocks. We would be happy to see a Good Rotation. Let’s review the latest data that we will continue to monitor in coming months:
(1) Savings deposits. It’s amazing to see that savings deposits (including money market deposit accounts) rose $4.5 trillion since the second week of March 2009 to a record high of $8.9 trillion during the final week of January this year (Fig. 7). Over the past 52 weeks, the amount in savings deposits is up $577 billion (Fig. 8). This really is money for nothing, with deposit rates near zero. If individual investors turn more bullish on equities as a result of Trump change, they might rotate out of their liquid assets rather than their bonds.
(2) Bond flows. Monthly data compiled by the Investment Company Institute show that bond mutual funds as well as ETF bond index funds together attracted net inflows during every month of 2016 except for November (Fig. 9). On a 12-month-sum basis, there have been significant bond inflows during the current bull market in equities with the exception of minor outflows during early 2014 (Fig. 10).
(3) Equity flows. A similar analysis for equities shows that mutual funds had outflows every month last year except during February, March, and December (Fig. 11). In contrast, equity ETFs had net outflows only during January and February. Together, they had inflows of $78.4 billion during December, the best monthly pace since December 2007.
(4) Good Rotation. December’s big inflow into aggregate equity funds might have been the start of the Good Rotation. It wasn’t a Great Rotation given that aggregate bond funds attracted $7.6 billion during December, following a net outflow of $6.6 billion during November. There’s no sign of a panic exit from the bond market into either cash or equities.
(5) Summing it up. Since the start of the equity bull market during March 2009, savings deposits are up $4.5 trillion, while net inflows into bond mutual funds have added up to $1.7 trillion (Fig. 12). Those are large chunks of change. Equity mutual funds’ net inflows, which are dominated by individual investors, have amounted to chump change, totaling just $205 billion. However, net inflows into equity ETFs, which reflect a more diverse universe of investors, totaled $1.1 trillion (Fig. 13).
Again, there is likely to be a large chunk of change in repatriated earnings going back into the stock market as additional buybacks and dividends. A Good Rotation by individual investors could unfold if the Fed continues to raise the federal funds rate at a gradual pace.
This all augurs for higher stock prices. The only problem is that valuations are awfully high. That problem could be solved by higher earnings if Trump succeeds in cutting corporate taxes and regulatory costs on business. If he also manages to cut personal income taxes and boost economic growth, that would help as well. The market is clearly betting that he just might succeed. So are we—for now.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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