The year began with commentators convinced the great rotation out of bonds and into stocks would accelerate through the course of 2014.  We were and have been skeptical of this notion based on our analysis of monetary policy.  We have developed a very simple model to understand the impact of the Fed’s decision to taper asset purchases.  In the chart below we show two things: 1) the three month change in total Fed assets and 2) 10 year US treasury bonds.

The blue line that extends down from today represents the trajectory of Fed asset accumulation assuming it sticks to its tapering schedule.  Our logic is simple: for the last four years bond yields have followed the ebb and flow of Fed asset purchases, and with the template clearly laid out, the glide-path for bonds was somewhat of an easy extrapolation.  Proponents of the great rotation narrative clearly were voting that the gravitational pull exerted by monetary policy would end.  Perhaps…but not yet.

When we apply our taper template to the developed world equity markets, we can see how monetary has also exerted a force on the equity markets.  In the chart below we show our taper template plotted alongside the relative performance of MSCI World Index counter-cyclical sectors (utility, telecom, health care and consumer staples) vs. cyclical sectors (energy, materials, financial, technology, industrials and financials). Similar to the glide-path for bonds, we think the trajectory of Fed asset accumulation suggests continued outperformance for counter-cyclical sectors.  These global counter-cyclicals have outperformed cyclicals by roughly 4% year to date, and it is easy to extrapolate another 5-7% of relative outperformance over the balance of the year.