Dollars and Sense: The 'Great Rotation,' S&P lawsuit, market volatility, and the Dell deal

The Great Rotation. Have you wondered why the stock markets are at near record highs even though the economy has remained sluggish for the past couple of years, and was in the Great Recession a couple of years before that? One cause is a phenomenon some analysts call “The Great Rotation.” When stocks started dropping in 2008 and 2009, that started an interesting series of events. People got scared and took their money out of the stock market. That caused it to drop further. In April 2009, the Dow was at about 6,600, less than half what it is today. Lots of that money went into bonds, even though bonds yielded terrible returns. But over the past few years, bond rates have remained too low to keep investors interested, and the economy has stabilized, taking some of the risk out of the stock markets. So money has rotated out of bonds and back into the stock market: “The Great Rotation.” According to Lipper, investors pumped more than $20 billion into stock funds in the first four weeks of this year, the best four-week period since early 2000. That’s a big part of what’s been fueling the stock market rise, even though the economy has been mediocre at best.

Free market barriers. We’re seeing a “Great Rotation” in part because of artificial barriers being placed on the free market. I’m amused when liberals complain about the cruelty of free-market capitalism, since the capitalism we practice here in the U.S. is not only subject to great regulation, but is also actively manipulated by extra-market forces. One of these forces is the Federal Reserve, which artificially depressed the interest rates that led to the housing bubble, which led to the financial industry crash. Also, free markets can’t exist without transparency and the free flow of information. The ratings agencies have historically been honest brokers of this information. We learned during the Great Recession we can’t trust them. This week, one of them, Standard & Poors, got a “hindrance” of its own: the federal government, joined by a number of states, sued S&P for $5 billion for its role in the financial crisis.

Volatility up. So how will we know if the “Great Rotation” has played out? There’s an old saying that when your waiter starts giving you stock tips, it’s time to get out of the market. Some analysts fear most of the smart money is already in the market, and has been for a while, and the money coming in now is at the lagging end of the trend. There’s not really any way of knowing that, but I will say we saw our first 100-point drop of the year on Monday, and volatility is one sign of an overheating market. A more reliable indicator of volatility is the Volatility Index, or VIX. The VIX was in the mid-20s last summer, and spiked again into the low 20s just before year-end, when the fiscal cliff deal was in doubt. It fell to about 12.5 in late January, and has been slowly creeping up since. It’s still low when compared to historic norms, but if you have money in the stock market, you might want to start paying attention to it, because things can and often do turn on a dime.

A coming thaw? You’ve got to admire Michael Dell. He’s put most of his fortune at risk to re-purchase the computer company he founded. On Tuesday, he said he would take Dell Computer private in a leveraged buy-out deal worth $24 billion, the largest LBO since the Great Recession. Analysts are waiting to see if this deal will break the deep-freeze in capital availability. Since 2009, LBOs and initial public offerings have hit a seriously cold streak. But corporate balance sheets are flush: some say the S&P 500 have as much as $2 trillion on their balance sheets. If the Dell deal goes well, others might ignore the ice floes in the economy and steam ahead.