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Well, so much for the "Great Rotation."

As billions of dollars have poured out of overpriced bonds and into stocks, some analysts have hailed the move as a seismic asset shift that could underpin a long bull run in equities.

In November, Michael Hartnett, the estimable chief investment strategist with Bank of America Merrill Lynch and Wall Street's leading tub-thumper for the rotation thesis, perused the results of his firm's latest fund manager survey, which showed money managers allocating more capital to equities and reducing net bond exposure for a fifth consecutive month. "Momentum has gathered behind the idea that we are on the cusp of a great rotation out of bonds and into equities," Mr. Hartnett declared. "The only missing ingredient is a resolution to the U.S. fiscal cliff."

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When nothing but some politicians' egos fell off the so-called fiscal cliff in January, Mr. Hartnett grew even more confident: "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."

By last week, though, the rotation was looking a little wobbly. For the first time in more than two months, more cash flowed into bond funds than their equity counterparts – $2.6-billion (U.S.) vs $1.8-billion – reports EPFR Global, which tracks international fund flows. And the most recent sounding by the American Association of Individual Investors revealed a decline in bullish equity sentiment to 42.3 per cent, a five-week low, although still above the long-term average of 39 per cent.

The AAII survey, which tracks expectations over the ensuing six months, revealed that a growing number of people have turned neutral on equity prospects. Not Mr. Hartnett, who reaffirmed that his "core 'Great Rotation' theme remains in play."

Yet amid mixed or deteriorating economic data on several fronts, critics were warning that if typically late-to-the-game retail investors are counting on stocks to restitch their tattered portfolios, they may be in for a nasty surprise, as fundamental problems with the global economy come home to roost.

This is beginning to look a lot like 2007, said Chris Martenson the other day.

"The markets right now are being driven more by liquidity than by fundamentals," said Mr. Martenson, an economic researcher and founder of – a financial web site. "These have very odd dynamics. They tend to continue [rising] until there's some silent message. It's like a dog whistle. Only dogs and investors can hear it. I can't predict when this is going to go. But it has all the earmarks of a liquidity-driven binge, with overpriced assets everywhere I look. I can't find any historical periods that make me think that ends well."

But what about the many analysts who insist stocks are cheap or at least fair value and that corporate profits will keep climbing?

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"It's possible, but I'm a big fan of reversion to the mean. Corporate profits are way out of alignment with historical averages. I don't understand the idea that profits can expand by 8 or 9 per cent in aggregate, while underneath all of that, we have nominal [U.S.] GDP growth of maybe 2 or 3 per cent."

And even that modest growth outlook may be too optimistic, insisted Mr. Martenson – a neurotoxicologist by training who has long warned that there will be no return to what passed as normal health in the years before the Great Financial Meltdown. The main reasons are simply too much debt relative to growth and the little acknowledged impact of chronically high oil costs on key economies.

"We are now in a world of persistently lower growth" that is not accounted for by the economic models on which most governments and central banks base their assumptions, he said. "Almost none of their models ask the question: What would happen if nominal GDP growth was not 4.5 per or 5 per cent? What if it was half that?"

If we are indeed trapped in a prolonged period of low growth, "almost nothing works out from a fiscal standpoint. Nothing works out well from a banking or monetary standpoint. Everything sort of shudders to a halt."

That doesn't mean investors have to sit around like rabbits caught in the headlights of oncoming traffic.

"I've been a big fan of trying to invest across the large trends," he said, noting that his own focus is broadly on energy, water and gold. Although he said he is prohibited from touting specific names, his view that oil will remain a depleting resource with high prices has led him to major service providers, including pipeline operators and those involved in advanced oil recovery and reservoir services.

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He has also been touting the benefits of a hefty weighting in gold for years, citing widening fiscal deficits, negative real interest rates and record levels of "monetary easiness or recklessness, depending on your view."

All in all, Mr. Martenson would rather keep playing defence, even as frustrated seekers of better returns go on the offence.

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More


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