The great rotation of 2013: fact or fiction?

Bold forecasts that 2013 will witness the start of a great rotation from fixed income into equities are premature, says Neill Nuttall of JP Morgan Asset Management – despite data to the contrary.

Already this year evidence is stacking up of a return to risk assets. The week to January 9 saw a net $22.2 billion flow into global equity funds, the highest level since September 2007, finds research house EPFR.

And yesterday Bank of America-Merrill Lynch published its latest fund manager survey showing that a net 51% of global investors were overweight equities in January, four times higher than a year ago.

Continuing this theme, the survey found that allocation to bonds had fallen to its lowest level since May 2011, with a net 53% of global fund managers underweight the asset class.

“Following resolution of the US fiscal cliff [a short-term fix delaying political sanction of scheduled budgetary tax rises and spending cuts], sentiment has surged,” noted Michael Hartnett, chief investment strategist within BoA Merrill’s global research arm.

“Half of investors now tell us that they would sell government bonds to buy higher-beta stocks, which is consistent with increasing growth and inflation expectations and with our call for a great rotation to start in 2013.”

However, Nuttall, London-based CIO and head of the global multi-asset group for JP Morgan AM, argues that it is too early to judge if investors are mounting a sustained return to equities, with institutions most notably in Europe still in a state of deleveraging.

“Any rally in equities is going to be from a liability-driven approach, so I think that headwinds for equities are still there,” says Nuttall.

This is likely referring to the regulatory concession that saw Basel III requirements for banks to hold a higher level of liquid, easy-to-sell assets watered down, allowing more asset types to count towards capital reserves.

“Clearly there’s a short-term switch [to equities],” Nuttall adds. “People are underinvested in equities, and I don’t know many who have fully benefited from last year’s rally. So I think there’s a short-term catch-up, but I don’t think the great rotation has started.”

If anywhere, continues Nuttall, a rotation may have started in Japan, where negative real interest rates are incentivising investors to turn to Japanese equities yielding 2.5-3%.

“Even if deflation goes to zero, what you are doing is increasing the real interest rate, which will be positive for risk assets, in particular equities,” Nuttall notes. This is supported in Japan by the fact that company balance sheets are strong, even amid weakness in the domestic economy.

Japan fund flow data from the BoA Merrill survey backs up this positive sentiment. Amid positive soundings from the new government of Shinzo Abe – in particular increased infrastructure and defence spending and a weakening of the yen – global fund managers are now a net 3% overweight Japanese equities, which represents a sharp reversal from last month’s net 20% underweight.

Further, the survey notes that this 3% allocation is dwarfed by the average 30% net overweight allocation to Japanese equities between 2003 and 2007 – indicating the level of room to grow.

When it comes to Asia-Pacific investors, the survey finds that China and Hong Kong are the most favoured markets, with 33% and 17% of respondents bullish, respectively. South Korea also saw a major upswing, from a net 7% underweight to a net 6% overweight.

At the other end of the scale, the Philippines, India and Australia were the region’s most unloved, with 11% of Asia-Pacific investors underweighting their equity markets.

By sector in this region, retail, energy and technology were the winners, with a net 33% of Asia-Pacific respondents overweighting these. By contrast, defensive stocks including consumer staples saw a dramatic decline, from a net 40% overweight, compared with neutral in December. Utilities also sank in allocation to 53% underweight, from 35% underweight the previous month.

Some 254 panellists with $754 billion under management took part in the BoA Merrill survey from January 4-10. Of those, 190 took part in the global survey and 131 in the regional ones, with some overlap between the two.