Friday, January 07, 2011

January 2011

The so-called January Effect appeared to begin unfolding in the first week of trading in 2011. The annual rise in stocks in January is often triggered by a rebound in stocks that were sold off in late December for tax loss purposes. Investors then pick up the cheap, downtrodden stocks in January. However, this year stocks may also get a boost the unique set of circumstances in the U.S. bond market. Prospects for economic recovery appear to have improved, as the unemployment rate has declined and new jobs have been created, albeit in small numbers than hoped for. Investor sentiment has improved and valuations have been expanding on the lower required risk return. Accordingly, many investors who have been holding bonds and are now near break-even in those positions may choose to liquidate those bonds and shift to the equity markets.

Thus we believe there is a great boost ahead for the U.S. equity market from a rotation out of the bond market into equities. The decline in interest rates is likely completed given the Federal’s Reserves Quantitative Easing II program. Thus bond prices are not likely to rise further from the current levels. Indeed, bond prices could not begin to drop. We expect sophisticated investors to move away from bonds to stocks. Money flows appear to back up our view. Indeed, U.S. bond funds experienced a net outflow of monies in December 2010. Most of the outflows were from municipal bonds and bond funds.

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