Understanding the ‘Great Rotation’

If you follow the chatter around the markets these days, it’s pretty hard to avoid the theme of the “great rotation.”

In a nutshell, market pundits believe that retail investors will decide that the money they have parked in U.S. Treasury debt and other “safe” investments, such as municipal bonds, soon will move into stocks — in a big way.

Recent surveys seem to back up this bet, at least superficially. Franklin Templeton, the fund manager, asked investors if the stock market was up, down or sideways over the course of the past few years.

Amazingly, most people got it totally wrong. By hefty double-digit margins, investors guessed that stocks were “down or flat” in 2009, 2010 and 2011, years in which the S&P 500 gained ground.

Those stocks gains had a lot to do, of course, with the fire sale in equities in 2008, when the S&P 500 saw a huge, even historic, one-year decline. Common sense would have told you that stocks would rebound after that, yet investors simply had a hard time conceiving of it, even years later.

Which is truly odd, considering the ubiquity of the indicator itself. If you spend any amount of time online or watching TV, the day’s progress of the market is hard to avoid. Stock ticker crawls are rampant, and we are exposed to the relative performance of the markets in about the same way we are told of football scores or changes in the weather.

Yet it’s the very breathless, up-to-the-minute nature of market updates that fools us. Think about the last 10 or 15 times you noticed the S&P or Dow numbers crawling by under a talking head on TV. Was it green? Or red?

Chances are, you wouldn’t be able to say with any confidence what the monthly or quarterly trend of stock values might be, unless you really paid attention and kept track.

The result of this piecemeal approach to reality is that we tend instead to remember the last time market news punched through the fog of information. That would have been during the credit crisis, of course, when stocks plummeted.

Because of the impact of that recent, painful memory, we’re stuck with the general presumption that “stock are down,” even if the facts are quite different. For instance, a well-allocated portfolio didn’t necessarily suffer the same fate as did a long-only stock portfolio in recent years. Bonds have had a great run.

The other mistake people make is to assume that a decline in equities means an automatic loss. This is true only for investors who panicked and sold at the bottom, and only if you discount dividends collected over the slump.

Are we due for a “great rotation” into stocks at the expense of fixed income and non-equity assets, and should you try to get ahead of it?

It is a truism that bull markets are often defined in their later stages by the entrance of large numbers of small investors. Mom and Pop might show up soon enough. The double-digit performance of the S&P 500 in 2012 caught more than few people by surprise. The positive first month of 2013, while typical of Januarys past, is food for thought.

Nevertheless, retirement investors should consider the risks of trying to time the markets. Ordinary investors, which is to say nearly all investors save for a few highly paid superstars, almost always “guess wrong” the direction of the markets.

Even the superstars get burned on occasion. They might have a given trend totally knocked and even manage to beat the indexes for several years in a row. Then, suddenly, you don’t hear about them anymore.

Why? Well, because market timing finally caught up with them. Very likely, that onetime star gave back all of his or her gains (or more) and decided to “retire” from the investing advice business. It happens.

The ‘great rotation’ in perspective

As a retirement investor, of course, you can’t just step back from the game because it doesn’t go your way, and you certainly won’t be collecting a fat severance package on the heels of a horrible performance. If you manage your own retirement money, there are no “oops” or “do-over” moments.

If you want to get a piece of the supposed “great rotation,” the simplest, safest strategy is to own a properly allocated portfolio that includes stocks — more if you’re aggressive or simply younger, less if you’re conservative or have a more limited investment horizon. Getting the upside without risking your neck is the key to retiring with more.