The notion that there will be a mass exodus from expensive US bonds into relatively cheap equities, dubbed “the great rotation”, is unwarranted, Lombard Odier Darier Hentsch has said.

While some individual investors can shift from one asset class to another it is not possible for this to happen in total as the outstanding stock of assets must be held by someone, the Swiss private bank said in a note, entitled Dispelling the Myth of the Great Rotation.

The bank responded to the theme, as highlighted for example by a cover article in the weekly magazine Barron’s, that such a large shift between asset classes, encouraged by valuations and still-cheap interest rates, will occur. Since the start of this year, there has been expectation of such a shift. In some cases, it is explained as a form of “financial repression”, as central banks, at the behest of governments, “punish” savers in cash and certain income assets with very low interest rates, forcing them to own riskier equities instead.

“As such, the fact that investors currently own lots of bonds (vs equities) is largely a reflection of strong supply. Indeed, the massive increase in leverage over the last decade has led to the market capitalisation of the bond market to rise. Meanwhile, the equity market has been shrinking with US companies using proceeds from debt issuance to buy back their own shares, taking advantage of the gap between (low) financing rates and (higher) cost of capital,” the firm said. 

“Is it possible, going forward, that higher demand for equities that are in “short” relative supply drives their prices up, and conversely for bonds? Clearly, such portfolio rebalancing lies at the very heart of ongoing global central banks’ interventions. By pushing down expected returns on low-risk assets, central bankers are attempting to force investors up the risk curve (read: buy equities), hoping that the induced wealth effect boost the economy,” Lombard Odier Darier Hentsch said.

“But as they accumulate vast amounts of bonds, they are also becoming the marginal buyer of that market. And a relatively price insensitive marginal buyer too, since their primary goal is not to generate an investment return but to support their countries’ financial system,” it said.

The pick-up in equity fund flows in the first weeks of this year is typical after a period of strong returns, the bank said, as there is a reaction to such performance. The bank cautions the latest issuance of big debt issuance to finance stock buybacks corresponded to market extremes, as in 2000 and 2007.

“All told, far from envisaging a sustained and large equity rally on the back of a “great rotation”, our best case scenario would be for the equity rally to lose some steam, and the worst case scenario for it to experience a significant sell-off. Protect your portfolio, and be ready to move out of equities back into government bonds when yields normalise,” it said.