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There is a massive sea change afoot for one of the most important stock market participants. While the footprints left by the US retail investor are easy to decipher, their rationale is a bit murkier to ascertain. For a while now, I’ve been pointing out the equity exodus by average Joe and Jane. But retail investors haven’t just been taking their chips off the table. Fund flows into fixed incomes have been positive at a rate that is almost beyond belief.
While many are pointing out the formation of an impressive bubble in fixed income, and others fretting at the tsunami of supply (paper issued by the US government), the real story is the demand side of the equation.
There are very few Treasury bulls out there. Hugh Hendry of Eclectica and David Rosenberg of Gluskin Sheff are two that come to mind (if you know of others, let me know). Rosenberg has been consistently writing about the secular shift as he believes it is one of the most powerful changes in the market right now.
He believes that this is a move with a lot of room still to run for one basic reason, the balance sheet of the US household:
- Households own $18.2 trillion of residential real estate, even after the value destruction of the past three years.
- Households own $18.1 trillion of equities, despite the vicious bear market.
- Households own a near-record $7.7 trillion of deposits and cash — earning next to nothing in yield.
- Households own $4.6 trillion of consumer durable goods.
- Households own $3.5 trillion of corporate bonds and municipal/agency paper
- Households own just $800 billion in Treasury notes and bonds.
Presented with those basic facts, it is not difficult to put the pieces together. The average household’s wealth is very underrepresented in fixed income. Some of that has to do with the strong equity culture in the US. You simply won’t find the same comfort level with equity ownership and trading in Europe for example. The key is that there seems to have been a moment of epiphany where the average Joe and Jane realized that their balance sheet was very lopsided.
No doubt that eureka! was sparked by several painful events: the real estate meltdown, the stock market bear market (on heels of the 2000 bear market, giving a zero decade long return) and the economic meltdown which either reduced or eliminated incomes (through the steep rise in unemployment). The result is that the babyboomers, facing a looming retirement, have retreated into the posture of capital preservation and income generation.
It was quite evident by last summer that suddenly after decades of neglect, the US consumer had rediscovered frugality and saving. Here’s an updated chart of the US savings rate (latest data point is for December 2009):
The US savings rate tells the story of the ferocious deleveraging going on in the private sector in the US. After amassing debts and consuming way beyond their means, the US consumer has hit the wall and rediscovered the religion of fiscal prudence. So while the public sector’s balance sheet is expanding like crazy to fight against the recession, the key question is will this private trend going the opposite direction nullify it?
According to ICI, for the period January 2009 to January 2010, the US investor has withdrawn $38 billion from domestic US mutual funds. They have shifted an almost equal amount into foreign equities ($40 billion). And of course, they have put the vast majority of their investing wealth into bonds: $410 billion and counting. The cyclical bull market in the US since March 2009 has been completely ignored:
The last little bars are partial data for February (so I colored them differently). Even with just the partial data for February, we are still going at a pace to match January’s fund flows. Needless to say, Rosenberg feels that the long term secular bull market in treasury notes is intact and any dips are buying opportunities. He believes that the deleveraging by the private sector will overpower the US government’s expansionary policies and ultimately bring about more deflation. So there you have the other side of the fixed income story (from someone much smarter than yours truly).
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