So by now you’ve all heard the “great rotation” theory.
Hell, maybe you’ve even perpetuated the meme (because that’s what it’s become).
The idea is pretty simple. As yields rise, investors will flee rate-sensitive assets and/or duration and head for equities. This is one argument for why stocks have further room to run despite sporting the highest Shiller P/E ratios since 1929 (ex. dot-com bubble).
This has turned into something of an online shouting match between those who believe in the theory and those who, like Goldman, think it’s “fake news.” While there are arguments on both sides, I’m kind of inclined to think that adding exposure to stocks or worse to HY (when both are clearly quite rich) in an effort to frontrun some kind of epochal shift out of quality and duration is a fool’s errand.
Whatever you believe, the data doesn’t lie and at least one corner of the fixed income market that’s not experiencing any kind of “rotation” let alone a “great” one is IG.
You’ll recall that investment grade supply has been strong (and that’s an understatement) in the new year as corporate management teams try to get out ahead of an expected rise in borrowing costs.
Well according to UBS, all of that supply is being supported by healthy demand. Consider the following excerpts (which I think are quite good) from a piece out Wednesday entitled “The Great Rotation? US IG Hasn’t Gotten The Memo”.
While this narrative continues to persist, the demand for US investment-grade credit continues almost obliviously. Last week was a great example. US investment-grade credit funds (as measured by Lipper) obtained $4.1bn of inflows through Jan 11th, the third largest in history going back to 1991. This does not appear to be a blip. If we analyze cumulative flows since the beginning of 2016 (as a % of AUM), US high-grade inflows continue to pile up, and in a materially stronger way than their high-yield brethren (Figure 1). Isolating average weekly flows pre and post the US election begets the same result. While all US credit markets have seen greater inflows post the US election due to a risk-on rally, US investment-grade demand has actually increased despite higher Treasury yields. The average weekly inflow for US IG credit has been $1.4bn post the US election, compared to $0.9bn pre the election (Figure 2).
What is this telling us? First, we should not be surprised by the performance of US high-grade credit to start out 2017. Credit spreads are unchanged, despite an onslaught of new supply ($81bn) that is the strongest on record at this early juncture. Most of these new deals have been well-received with negative concessions. If offshore cash repatriation through corporate tax reform were to be passed early enough in 2017, this would create a strong technical tailwind for the asset class (we estimate this could reduce supply by 13% Y/Y). But even in its absence, the IG market should be able to absorb high issuance totals again in 2017.
In addition, “the great rotation” theme within credit appears to be exaggerated. It is true that lower-quality floating-rate bank loans inflows have been red (or even white) hot since the bottom in US Treasury yields in July 2016. However, US high yield flows have only improved to a modest extent, despite a lower duration and higher risk profile. It is one of the oddities of 2016 that US high-yield surged with below average inflows. Clearly, 2016 taught us that inflows are not needed for major performance gains; fund manager positioning and underlying market illiquidity can work just as well. But we still have failed to receive an upside breakout in high-yield inflows, like that seen in IG credit and loans.