Along with most of his Wall Street peers, BofA’s Chief Investment Strategist Michael Hartnett flipped his outlook on risk assets shortly after the election, turning from quietly bearish to vocally bullish and forecasting a substantial rise in US equities, and even more substantial bounce for Japanese, European and UK stocks as well as oil.
So far, Hartnett has been correct, and according to recent fund flows, much of the investing community agrees.
Some specifics: in the last week, according to EPFR, there were both strong bond inflows ($6.3bn) as well as equity inflows ($5.5bn) offset by modest commodity outflows ($0.2bn). Curiously, unlike in the earlier part of the reflation trade when buying of equities was funding from bond liquidations, last week we saw the strongest week of bond inflows in 3 months, which followed $41.5bn of redemptions in past 8-weeks – the largest redemptions since taper tantrum.
A more nuanced look into bond flows shows that investors added risk, with another week of redemptions from Treasuries but 1st inflows to EM debt funds in 9 weeks, 2nd week of renewed inflows to IG bond funds, and 6th consecutive week of inflows to HY bond funds. In other words, “risk proxies” in the bond world are getting hot again.
Perhaps nowhere is this more obvious than what is going on in the primary issuance market. Here, as Bloomberg notes, debt sales are blowing through all records, with the biggest volumes of issuance ever for the first week of January, as top-rated U.S. companies are selling bonds at the fastest pace ever to start a year
And while gold & EM equities remained shunned, which gold posting an 8th consecutive week of outflows, the longest outflow streak in 3 years, as well as European & EM equities, which are largely ignored by investors, US equities remain quite hospitable, attracting $5.5 billion in new funds in the past week. By sector, EPFr notes that there were 15 straight weeks of financials inflows ($0.8bn); first inflows to REITs in 9 weeks ($0.7bn); 6 straight weeks of healthcare outflows ($0.2bn) Sadly for the active management community, there was more bad news as ETFs attracted $9.2 billion in the first week of the year, offset by $3.7 billion in long-only fund outflows.
In fact, as the chart below shows, the amount of funds that has flowed into US equities is starting to be of concern to some analysts who see in this unprecedented inflow signs of euphoria.
In a report last week, TrimTabs Investment Research also noted this unprecedented fund flow euphoria when it reported that U.S. equity ETFs issued a record $59.9 billion in December, easily surpassing the previous record of $50.7 billion in November.
So after this unprecedented deluge in new funds chasing stocks, where are we now? According to Hartnett, there are two answers: a tactical and a structural one:
Tactically: a wobble in risk assets would be no surprise in coming weeks; traders looking to play a pullback (on “sell the inauguration” or “here comes the Fed” or “CNY-reversal” themes) should note since US election the big inflows (and pullback risks) concentrated in US stocks, financials, bank loans, US value stocks, High Yield (see Chart 1); in contrast, EM, US growth stocks, Treasuries, Gold & IG have less vulnerability to profit-taking.
As a reminder, it was Morgan Stanley’s chief equity strategist Adam Parker who last week called to fade the Trump rally and “Sell the Inauguration” as “the world has materially changed”. On Friday, none other than Wall Street’s most famous permabull Tom Lee suddenly became its biggest bear when he said the S&P would like slide to 2,150 by June 30, before rebounding modestly to 2,275, ending the year largely unchanged.
Hartnett disagrees because while he notes that a tactical selloff may come, “structurally” the rally will continue.
Structurally: we remain bullish risk in coming quarters (expecting double digits for Japan, Europe, UK stocks, and oil; single digits for US stocks, commodities, the USD & Emerging Markets; low/negative returns for corporate & government bonds).
What would change his mind? Even more euphoria: “We will wait for unambiguous signs of bullish investor Positioning, bullish Profit expectations & hawkish Policy from Fed/ECB, as well as outperformance from laggard risk assets in 2016 (e.g. Europe/UK – Table 1) before calling for The Big Short.”
Then again, if Dow 19,999.63 can’t do it, we wonder if Dow 20,000.01 will be the long-awaited catalyst that finally unleashes the final euphoric spasm into US stocks.
