A great rotation, which signals a shift of funds from bonds to stocks, is underway as global interest rates show an upward trend. For example, the 10-year US Treasury Bond rate jumped to 2.483% on July 22 (local time), 0.871 percentage point higher than this year’s low recorded on May 1. Global investors are moving out of bond-type funds and flocking to stock-type funds under such circumstances. The Korea Composite Stock Price Index (KOSPI), in the meantime, bounced back to 1,900 points on July 23, further increasing the expectations of many.
Concerns over an increase in interest rates are on the rise. “Investors are considering 3% the psychological barrier for 10-year Treasury Bonds, and if the interest rate goes over that, the US economy is likely to face some negative impact,” said Frederic Neumann, cohead of Asian economic research at HSBC Holdings Plc, adding, “The problem is that the interest rate is rising too early and too fast.”
According to the Korea Center for International Finance, four out of the seven major global investment banks revised upward their estimates for 10-year Japanese government bond yields for the third quarter of this year. Goldman Sachs predicted the annual yield rate would go up from 0.88% to 1.00% in the latter half and to 1.10% in Q2 next year. This was followed by Barclays (from 0.55% to 0.85%), Citi (0.60% to 0.80%) and Credit Suisse (0.55% to 0.85%).
The 10-year government bond yields of the US and Germany are also predicted to rise. On May 24, JP Morgan adjusted its forecast for the former from 1.85% to 2.25% for Q3, 2013.
Experts are rather divided regarding the issue. Some see the interest rate hike as a natural consequence of the global economic recovery, while others interpret it as the beginning of a great rotation.
According to Emerging Portfolio Fund Research, a total of US$21.3 billion flew into stock-type funds between July 11 and 17, US$17.5 billion of this into US stock funds. The amount is the largest since 2009.
At the same time, an exodus of money from bond funds is accelerating, particularly in emerging economies. US$1.3 billion was withdrawn from these countries in the past week, recording a net outflow for eight consecutive weeks. US bond funds lost US$2.7 billion during the same period as well. This capital outflow has continued since the first week of June, with the exception of one week. Last month, BOA Merrill Lynch’s global research team held a press conference at their Manhattan office and stated that the popularity of bonds that had continued for 30 years or so was declining and that a great rotation would continue until 2015.
Time Not yet Ripe for Great Rotation
The declaration of the US that it would reduce quantitative easing is regarded as the end of the low interest rate era, and thus signaling a sluggish bond market. However, the movement of funds is unlikely to be rapid during the great rotation.
“Although interest rates are going up, countries around the world have different growth potentials and volatility factors,” said Choi Seung-yong, a Taurus Investment & Securities research analyst. He added, “Therefore, the recovery of stock markets is expected to occur at different speeds down the road.”
However, there are some market insiders who think the great rotation will take more time to appear. “Investors are focusing only on the Fed’s exit strategy,” said Korea Investment & Securities researcher Lee Da-seul, adding, “However, it is probable that they will face great uncertainties first before expecting something from the stock market in the second half.”
There is no saying if the trend will have a positive effect on the Korean bourse. Korea Investment & Securities analyst Roh Keunhwan remarked, “The stabilization of the value of the US dollar and a recovery in corporate earnings are key for the domestic stock market to enjoy the great rotation.” Meanwhile, Hyundai Securities researcher Kong Won-bae stated, “Considering the flow of index funds abroad and the national economic growth rate, Korea is one of the most attractive investment targets.”