WSJ (2/15/13): “Beware the Great Rotation”

fee-only financial planners, stress-free financial planningStocks have continued upward (6-7%) in 2013 while bond performance has been flat or slightly negative since January 1st. Not surprisingly, many feel a “great rotation” has started and the stock market will “melt up” as investors sour on bonds and move from fixed investments to equities. Not so fast.

Since 1970, according to the Investment Company Institute, approximately 71% of all mutual funds were invested in stocks. At the end of 2012, that percentage was 65.7%. Hence, the current allocations to stock mutual funds are not abnormally low. Furthermore, in a study published last May in the Journal of Financial Economics, it was determined that even though the stock market often rises when investors move from fixed to equities, almost all of that increase is reversed in four months time.

Michael Kahn in the Barron’s issue Saturday cautioned that technical analysis would show that the stock market may be near a top.  Volume has been shrinking and many pundits are calling for a needed “correction.” Furthermore, the market has gone 15 months without a 10% correction and three months since a 5% correction. According to Mr. Kahn, a correction may be near.

Most importantly, we’re all waiting for Washington to govern. Certainly part of our current sluggish growth is the result of the financial crisis of 2008 and deleveraging. But an equally important factor is the uncertain economic and tax environment in our country. On Friday, Fed Chairman Ben Bernanke said that the U.S. economy is “far from operating at full strength.”  And now retailers are feeling the impact of increased payroll taxes as of 1/1/13.  January and early February sales were not good for Wal-Mart and others.

And, on March 1st, unless Washington acts, the sequester cuts will occur. This will cut $85 billion from discretionary spending; reducing defense programs by 8% and domestic programs by 5%. It is estimated these cuts will cost the economy more than one million jobs over the next two years. Certainly, we need to reduce the deficit and, at the same time, look at a potential Grand Bargain to deal with spending, investment and tax reform. We need a long-term fiscal restructuring for social security and Medicare.

Unfortunately, Washington is deeply divided. Thomas Friedman on Sunday put it this way:  “You can feel the economy wants to launch, but Washington is sitting on the national mood button. We the people still feel like children of permanently divorcing parents.”

There are lots of good signs out there. The American economy is recovering. Housing is coming back. The energy revolution is reducing costs. Financial sector and household balance sheets are looking better. What we need now is to break the deadlock in Washington. When that happens, our economy can start moving toward full strength. Only then, are we likely to see the real great rotation take place.