The equity cult alive and kicking, despite deflation threat

Wed Oct 29, 2014 1:47am EDT
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By Jamie McGeever

LONDON (Reuters) - Anyone betting on another "Great Rotation" of investment flows out of bonds and into stocks is in for disappointment: it's not happening, and isn't going to.

In a world where deflation, never the most fertile ground for equities, is a bigger concern for policymakers than inflation, that seems a pretty safe call - but the surprise is that this time around both asset classes may be on to a winner.

Bonds tend to do better than stocks when inflation is weak because the value of the fixed income payments investors receive is protected. In periods of deflation the real rate of return is actually enhanced.

But many of the world's leading investment banks argue that the broader market backdrop - also characterized by low interest rates, low returns and high cash balances - leaves stocks just as well-positioned to benefit as bonds.

Even as the U.S. Federal Reserve withdraws its stimulus, there is a surplus of savings and central bank liquidity in the global financial system that needs to find an investment home.

"The equity cult and the bond cult can live side by side," according to Citi.

As a group, U.S. financial institutions are among the biggest investors on the planet, with more than $60 trillion of assets under management, according to UBS. And they are loading up on stocks.

U.S. mutual funds' net investment flows in stocks over a five-year rolling period troughed at round $550 billion net outflow in late 2012 compared with a peak net inflow of over $1 trillion at the end of the millennium, Citi analysis shows.   Continued...

Traders laugh as they work on the floor of the New York Stock Exchange as the market closes in New York October 17, 2014.  REUTERS/Lucas Jackson