The times, they are a changin’.
Nicholas Colas, Co-founder of DataTrek Research, noted in a piece recently that over the last 3 years US investors have shifted capital in 2 ways. He says that – First, they are moving capital out of US stocks and into fixed income at an accelerating rate. Second, they are up-risking their remaining equity exposure to keep portfolio expected returns somewhat constant. And the result is growth stocks get an ever-larger premium, value languishes, and rates remain low from a persistent bid driven by asset reallocation.
Here is his report in its entirety:
Even with the remarkable stock market rally of the last several years, American investors have accelerated their sales of US equities and pushed ever more capital into fixed income (which has, of course, also done well). The latest money flow data through 2019/YTD 2020 from the Investment Company Institute, which includes both mutual and exchange traded funds, shows this clearly enough:
- 2017: US equity outflows of $50.0 billion, fixed income inflows of $380.7 billion
- 2018: US equity outflows of $111.7 billion, fixed income inflows of $100.4 billion
- 2019: US equity outflows of $169.5 billion, fixed income inflows of $458.5 billion
- January 2020 continues the trend: US equity outflows of $33.7 billion, fixed income inflows of $71.2 billion
This de-risking is also evident in the ICI data for non-US equity flows, although a part of this downward trend is also likely due to persistent underperformance:
- 2017: inflows of $236.6 billion
- 2018: inflows of $64.4 billion
- 2019: outflows of $30.0 billion
- January 2020: inflows of $12.9 billion, an anomaly we’ll get to in a minute
We see the same trend when we look at just ETF money flows, which represent both “fresh money” and the destination for capital that is leaving mutual funds:
- Over the last 5 years, the split of ETF money flows was 66% equities/30% fixed income.
- But over the last 3 years that downshifts to 63% equity funds/33% fixed income.
- Over just the last year, 53% of ETF flows went to equity products and 39% to fixed income. Yes, getting closer to 50-50.
- YTD 2020 shows a modest bounce back in equity allocation, to 59% of total inflows and 32% to fixed income.
The latest ETF money flow data through yesterday (2/7) shows how this de-risking is filtering through to investment decisions so far in 2020:
- Small cap equities are out of favor, with YTD outflows of $2.4 billion, all from redemptions of IWM (iShares Russell 2000) of $3.9 billion.
- ETF investors have a strong bias to funds that either focus on large caps (33% of total YTD ETF inflows) or at least include them in broad market indices (30%).
- To offset incrementally lower aggregate equity exposure than before (our point above), ETF investors are adding risk to what they are buying in 2020.
Emerging Market ETF inflows this year total $2.4 billion, some 65% of all capital added to the space in the last 12 months.
Growth equity ETFs show $2.1 billion of inflows YTD; Value funds are down $2.5 billion from redemptions.
Sector ETF money flows YTD show a strong slant to Tech (+$2.4 billion), Consumer Cyclicals (+$950 million), Industrials (+$822 million) and Materials (+$420 million). Money flows into defensive groups are either small or negative: Real Estate (-$252 million), Utilities (+$283 million), and Consumer Staples (-$173 million).
That final point is the key takeaway from all this: as investors have cut back on stock exposure, they are shifting their equity risk profile higher to keep portfolio expected returns somewhat constant. This has been true for longer than just YTD 2020, and the long run implications include:
- Higher valuations for growth equities. We see this in US large cap technology, for example, where the current forward PE is 22.5x, well above its 5- and 10-year average of 17.5x and 15.2x respectively.
- Static/lower valuations for low-growth sectors like Energy (16.2x now, 20.4x 10-year average) and Financials (13.2x now, 12.3x 10-year average) or where regulatory risk looms such as Health Care (15.9x now, 14.4x 10-year average).
- Higher overall valuations for large cap equities as Technology takes an ever-larger share of indices like the S&P 500.
- Structurally lower bond yields as money continues to flow to that asset class.
The last remaining question to address: why are investors shifting capital to fixed income, resulting in a shift in equity risk preferences? Two possible answers. One is demographics; an aging population will seek yield over capital appreciation. The other is market sentiment; as long as equities perform well the “fear of missing out” will prevail. The first is permanent; the second is, of course, much more uncertain.
Sources:
ICI Data: https://www.ici.org/research/stats/flows/combined/combined_flows_02_05_20
ETF Money Flow Data: www.xtf.com
