Investors are constantly plagued by questions for which there’s not always an easy and straightforward answer available.
How much exactly is the landscape for retail landlords changing? Is the trend towards less globalisation irreversible? What stocks and sectors are being impacted by riots in streets across the United States?
Probably the most important questions right now are, after such a strong recovery from beaten down index levels in March, how much upside is left in the short to medium term, and what is most likely to happen next?
Recent share market updates by analysts at Citi and Barclays, based on financial data insights provided by EPFR, will surprise most of you, but also provide some important clues.
Looking for Answers
Financial intelligence platform EPFR specialises in digging into global funds flows capturing both large institutions and retail investors.
EPFR data, but more so the insights derived from the data, are highly sought after by market analysts and strategists trying to decipher the global mood and latest movements.
Picture their surprise when the latest data update showed virtually nobody had been buying post the March 23 bottom in global equity markets.
Net funds flows into global equities have been on a sharp downtrend ever since the late 2018 conniptions, and calendar 2020 has simply continued that trend. Moreover, institutional investors including hedge funds kept on raising more cash as equities started rallying into April and May.
This raises two obvious questions:
-who has been buying in the past two months?
-what do these institutions intend to do with all that cash now equity markets have rallied so strongly?
Let’s tackle the first question first, as I am sure I now have your attention.
Declining funds flows while equities are rising is not as unusual as we all tend to think. Instinctively, it doesn’t make sense, but in practice equities can rally higher, and continue rallying higher, while more investors are withdrawing their money from equities.
It happened during the euro-crisis of 2011/12 and extended post-crisis further into 2013. It happened again in 2018/19.
Previously, buybacks from a growing number of US companies are believed to have made up the key difference.
This time around US companies have -for obvious reasons- stopped buying in their own shares.
So who has been buying instead?
Both Citi and Barclays point the finger at the same source: short sellers closing out their positions.
While in Australia there is anecdotal evidence the sell-off into March has attracted many fresh and returning retail investors, the EPFR data suggest no such retail participation revival has taken place in the USA.
Also, while the local ETF industry seems to have seen a boost of fresh inflows on the back of heightened market volatility, again, EPFR data reveal both active and passive money flows have declined so far this year globally.
It seems Australia has danced to its own tune post March 23. Australian indices still underperformed US benchmarks, and by quite the margin too.
After falling further than US share indices, the ASX200 had recovered by nearly 31% at the end of May with the S&P500 up 36% and the Nasdaq up 38% over the same period.
Also, the underlying trend towards passive investing very much remains intact. Over the last 12 months, investors moved -US$541bn out of active equity funds and US$327bn into passive alternatives.
The equally surprising, and important, observation from the EPFR-gathered insights is that in March investors globally shifted their money out of bonds, at the same time as they were selling equities.
Analysts at Citi go as far as to make the point that money flowing away from bonds is the most important narrative of March this year. Reaching a total net withdrawal of -US$445bn, outflows from bond funds in March is labelled “unprecedented”.
Luckily, Citi analysts note, central banks managed to stop the rout, with inflows returning in April. Notably, high yield bond funds recovered all their March outflows the next month.
EPFR data show money has kept flowing into US corporate bonds (“credit”) ever since the Federal Reserve declared themselves buyers into that particular market segment, though investors’ enthusiasm is not replicated in Europe or Emerging Markets (both clearly still seen as high risk).
The one positive remark to make is that, when placed in a larger context, this year’s net outflows from equities are not super-sized. As pointed out by Citi, since February there have been -US$120bn in redemptions whereas December 2018 alone saw redemptions amount to -US$105bn.
The added background here is that net outflows post late 2018 have only gone south ever since.
So, less investors are keeping their money with equities, but less traditional market participants such as the listed corporations themselves and short sellers pulling up stumps after making stellar profits are keeping this bull market for equities going for longer.
It’s hardly surprising this bull market for equities is constantly referred to as the most hated in history.
Not that investors who kept their money in the market, or those who have been buying freshly after March 23 will feel a need to complain.
All this does beg the question: what does it mean for the outlook of equity markets? Those short sellers that have been buying over the past two months are now done.
But equity prices are by now a lot higher too, and average cash levels are bloated.
Year-to-date, the largest beneficiaries of global funds flows are US corporate credit, US government bonds and cash and equivalents. According to the data, mutual funds in the US are sitting on their highest cash levels on record.
In addition, note analysts at Barclays, market positioning for these mutual funds, and for many an institutional investor across the world, is still very defensive.
The combination of both should translate into limited downside risk for equity markets, Barclays suggests.
But, but, but!
While it is easy to conclude the April-May rally in local and global equity markets, led by short sellers and daring retail investors, will soon force the hand of cautious institutions, pushing equity markets a lot higher, strategists at European powerhouse Amundi are not so convinced.
Amundi remains of the view that risk remains very well alive for risk assets, suggesting investors start making small allocations to market laggards and cyclicals, but with a conservative and cautious bias overall.
The Paris-headquartered asset manager distinguishes three key areas that may well deliver the next major disappointment for current “risk ignorant” equity markets:
-the covid-19 pandemic; markets have casually adopted the view the worst is behind us and there will not be a second or third wave. Plus, we’ll have one of several vaccines available in the next few months;
-the economic recovery; investors are willing to price in positive scenarios on the back of huge fiscal and monetary support measures;
-the credit cycle; on Amundi’s assessment, credit markets have priced in a first round of defaults, but not a second follow-up for traditionally laggard assets. Plus, the battle between liquidity and solvency is as yet far from decided. Amundi is closely monitoring US commercial real estate.
Amundi’s view is probably best described as “tell them they’re dreaming”. The advice to investors is thus not to chase current momentum, but instead to gradually and selectively play investment themes better positioned towards a slow road to recovery.
Other risks to consider for investors include rising tensions between China and the US, the uncertain outcome of the approaching US presidential election, idiosyncratic risks in emerging markets (such as Brazil) and longer-term consequences from this year’s pandemic (many not yet quantified).
Amundi’s conviction call that investors should stay vigilant and cautious is being complemented by Citi’s Panic/Euphoria indicator now warning market sentiment has moved back into a state of euphoria.
History suggests pull backs will occur next, even though the exact timing remains unknown.
Investors should note a number of technical analysts and trading systems would back up the signal provided by Citi’s indicator.
For example, Lance Roberts from US based Real Investment Advice, reported on the weekend every single short-term momentum indicator he watches for US shares is currently signaling overbought conditions.
But this need not spell another period of disaster and mayhem ahead.
From the start of what seemed at that time the arrival of an ugly bear market in February, I have stated the path and duration of whatever lays ahead shall be determined by future news flow.
Over the past two months the news flow has been predominantly positive, if we dismiss the humanitarian side of this crisis, and this has subsequently facilitated a surprisingly positive outcome for equity markets.
It is well possible that truly negative news and surprises may not announce themselves until much later, which leaves cashed-up institutions in a rather uncomfortable position.
What to do? And when?
As shown last week when shares in major Aussie banks suddenly caught a brief tsunami of buying orders, that cash on the sidelines is most likely attracted to momentum laggards and cheaper-priced cyclicals when it does decide to move into risk assets.
I also note share prices for quality safe havens such as Woolworths ((WOW)), Coles ((COL)) and CSL ((CSL)) have come under pressure while gains of 50% and more could be quickly had near the bottom of the domestic market.
It’ll be interesting to watch how, when and how many times market momentum switches between prior performers (Tech & Growth + Quality) and the value side of the share market.
Overall, one senses that with so much cash on the side, buying into dips might well have become the standard approach for many an institutional investor. This, by definition, limits the downside risk, at least for the time being.
For investors who hold many of the quality and growth stocks in portfolio, the key danger is that a sudden improvement in the economic outlook can spark a fierce return of money flowing into banks, resources stocks and other cyclicals similar to the switch that characterised the final quarter of 2016.
The threat for such a sharp transition in market momentum is further exacerbated by the historically wider-than-usual gap between Winners and Laggards.
Some level of catch-up seems but logical, if not necessary. Last week’s universal rally in banks, and the persistent lack of buyers’ interest in stocks I mentioned, are likely part of this process.
Meanwhile, share markets will continue asking questions of investors, including what risks are you most afraid of, and which stocks are best suited for your portfolio and strategy?
Depending on one’s personal objectives, horizon and investment strategy, the answers given in response to such questions might look a lot different between market participants.
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