From Dr John

"The newest iteration of the bullish case is the idea of a “great rotation” from bonds and cash to stocks, as if the outstanding quantity of each is not held by someone at every point in time. The head of a “too big to fail” investment firm argued last week that stocks are “underowned” – as if every share of stock presently in existence is not actually owned by someone. To assert that stocks can be “underowned” seems to reflect either a misunderstanding of how markets work, or a desire to distribute overvalued institutional holdings onto the unwashed muppets. Likewise, the idea of a “rotation” out of bonds and into stocks begs the question of who will buy the bonds and sell the stocks, as someone must be on the other side of that trade. Similarly, to “move cash into the market” requires a seller of stock who becomes the new holder of said cash.

Quite simply, the reason that pension funds and other investors hold more bonds relative to stocks than they have historically is that there are more bonds outstanding, relative to stocks, than there have been historically. What is viewed as “underinvestment” in stocks is actually a symptom of a rise in the gross indebtedness of the global economy, enabled and encouraged by quantitative easing of central banks, which have been successful in suppressing all apparent costs of that releveraging.

The "rotation" fallacy has emerged even in the work of analysts that we admire. Ray Dalio of Bridgewater talked on CNBC last week of a move “out of” cash and “into” stocks, seemingly reversing comments he made only weeks ago at the Dealbook conference (h/t PragCap) where he suggested that risk premiums are likely to expand, that the effects of QE are diminishing as we do more rounds, that we’re facing austerity, that growth is flagging, that the economy is facing unprecedented risk, and that we face a slowdown with very little room to maneuver. Meanwhile, Albert Edwards of SocGen suggested that there has been an excessive “move away from equities” in recent years – instead of noting, for example, that the volume of U.S. government debt foisted upon the public (even excluding what has been purchased by the Fed) has doubled since 2007, not to mention other sources of global debt issuance, while the market capitalization of stocks has merely recovered to its previously overvalued highs.

It’s fine to argue that perhaps investors are momentum chasers, and with profit margins now about 70% above historical norms (making stocks seem both "safe" and misleadingly cheap), with stock prices up, and with low returns on cash, investors not holding stocks will be the greater fools that allow investors who do hold stocks to get out. Indeed, that is an argument that I fully embrace as logical – the only issue being the extent to which one wants to assume the perpetual existence of a greater fool, as the supply of greater fools seems increasingly exhausted. But the problem with the “great rotation” argument is that somebody has to hold the debt. Somebody has to hold the cash. It cannot go anywhere, and it is impossible – in aggregate – for the markets to “rotate” out of it."

..."As of last week, market conditions joined 1929, 1972, 2000, 2007 and 2011 (less memorable, but still associated with a near-20% market decline) as one of the worst periods on record to accept market risk, based on the syndrome of overvalued, overbought, overbullish, rising-yield conditions presently in place. These conditions comprise the following: S&P 500 overvalued with the Shiller P/E (the ratio of the S&P 500 to the 10-year average of inflation-adjusted earnings) greater than 18; overbought with the S&P 500 within 3% of its upper Bollinger band (2 standard deviations above the 20-period average) at daily, weekly, and monthly resolutions, more than 7% above its 52-week smoothing, and more than 50% above its 4-year low;overbullish with the 2-week average of advisory bullishness (Investors Intelligence) greater than 52% and bearishness below 28%; and yields rising with the 10-year Treasury bond yield higher than 6-months earlier. The present instance may turn out differently than past ones. The enthusiasm of investors here certainly encourages that belief. Then again, virtually by definition of the foregoing syndrome, investors were equally enthusiastic at those prior market peaks."


http://www.hussman.net/wmc/wmc130128.htm