Picture a giant wheel moving ever so slowly up a hill. When you look at it from the side, you can see two dots on the edge that are directly opposite each other. As the wheel moves, those dots rotate. As one dot is on top the other is on the bottom. As the wheel continues to rotate, the dot that was on the bottom will eventually get back to the top and vice versa. This mental illustration that you have drawn demonstrates the relationship between stocks and bonds over time.
When the stock market1 dropped over 55 percent, from October 2007 to March of 2009, the giant wheel ended up with stocks on the bottom and bonds on top. This happened as people and institutions pulled some of their money out of stocks and put it into the relative safety of bonds.
Fast forward almost five years and now that trend is reversing. 2013 saw some of the largest outflows from bonds with the money going into stocks.2 As CNBC writer Dhara Ranasinghe puts it, “A ‘Great Rotation’ out of bonds into stocks is only just underway and is setting up to be one of the major investment themes of 2014.”3
It is important to note that this great rotation takes time. It doesn’t just happen overnight. It has been almost five years since the stock market bottom of 2009 and it may take more time before stocks hit the top.
One of the drivers of the great rotation is inflation. Inflation is bad for bonds as it makes them worth less. Inflation could ensure that bonds stay on the bottom of the giant wheel for a while.
There are long-term signs that are positive for the economy and stocks. The housing market is coming back, U.S. oil and gas production is booming, and a manufacturing renaissance is taking place.4 This could lead to good long-term growth for stocks.
Along the way there will always be bumps in the road which result in short-lived reversals of the great rotation. However, the giant wheel keeps moving slowly. For now, that means that stocks are king of the mountain. Of course there are no guarantees.
1. The stock market defined as the S&P 500
2. Roben Farzad, “In Search of the Great Rotation,” Bloomberg Business Week, Aug 23,2013: http://www.businessweek.com/articles/2013-08-23/ in-search-of-the-great-rotation
3. Dhara Ranasinghe, “And We’re Off: the Great Rotation Gets Into Gear,” CNBC, Nov 20, 2013: http://www.cnbc.com/id/101212837
4. Fidelity, Investment Themes Quarterly Update, July 2013
Research by SFS. Data from public sources. This is not a recommendation to purchase any type of investment. Investing involves risk, including potential loss of principal. The Barclays U.S. Aggregate Bond Index, Dow, and S&P 500 are indexes considered to represent the U.S. market. One cannot invest directly in an index Past performance does not guarantee future results. The opinions and forecasts expressed are those of the author and may not actually come to pass. This information is subject to change at any time, based on market and other conditions, and should not be construed as a recommendation of any specific security or investment plan.