Last month, JPMorgan outlined a call for a big shift in investor positioning into stocks and out of bonds in 2020.
That would mark a break with 2019, a year defined by fixed income flows despite the run-up in equities.
“We look for 2020 to be the year of Great Rotation II, in a repeat of 2013 the year of Great Rotation I”, the bank wrote, projecting an epic pivot. (The following chart is current through December 15.)
While it’s far too early to take stock (and there’s a bad pun in there) of the situation, the bank says in a new piece that the flow picture so far in the new year is not consistent with any rotation into equities and away from bonds – “great” or otherwise.
So far, flows into bonds have continued, while equity funds have enjoyed but modest inflows.
Do the MTD numbers for January matter? Well, yes. They matter a lot, actually, both in absolute terms and from a signaling effect perspective.
“January is typically a month when retail investors make their asset allocations for the whole year [and] empirically there is a significant positive relationship between the full year equity fund vs. the January flow”, JPMorgan’s Nikolaos Panigirtzoglou writes, in a note dated January 17. He goes on to say that “during the previous Great Rotation year of 2013 when we had a big positive equity fund flow shift [like] the one we anticipate for this year, January saw a high share of almost 20% of the yearly equity fund inflow”.
After recapping the rationale behind the “Great Rotation II” thesis, Panigirtzoglou zooms in on one of the key impediments to the call playing out – namely already elevated retail investor positioning which, as the bank cautioned last month, would “need to rise beyond previous equity cycle peaks for the Great Rotation thesis to play out this year”.
As you might imagine, the Q4 rally made that already elevated positioning even more elevated. In fact, a retail investor positioning proxy extrapolated through January 16 “currently stands at record high levels for funds domiciled worldwide and very close to record high levels for funds domiciled in the US”, JPMorgan writes.
That metric does not capture stocks held directly (i.e., it measures equities held in funds). So, JPMorgan also uses the Flow of Funds report to measure the stock allocation of US households. Of course, that has its own problems. Most notably, it captures institutional money, hedge funds and some private equity – hardly “households”. But when considered in conjunction with the above, the two provide a useful snapshot. Here’s Panigirtzoglou:
The last observation available is for Q3 2019. But our extrapolation based on equity and bond returns up until January 16th shown by the dot in Figure 5, suggests that US households are starting 2020 at a new cycle high in terms of their equity allocation. Their current equity allocation represents their most overweight equity position since the end of 2000, albeit some way from the historical peak of Q1 2000.
The upshot is that retail investors are too long to get any longer without stretching their allocation to historic extremes. That, in turn, presents a major challenge to any “Great Rotation II” thesis.
And yet, January’s outsized importance notwithstanding, two or three weeks does not a year make, and the bank will surely revisit this once the complete data for the month is available. For now, JPMorgan describes the chances of an epochal shift away from bonds and into equities as still “decent” despite wrong-way flows in January.
Draw your own conclusions.