Two “Data” topics today:
#1: The latest on US mutual/exchange traded fund flows.
We have been covering these more regularly this year than previously because, well, they finally matter again. There was a time, pre-Financial Crisis, when fund flows were positive (especially in the 1990s) and actually explained stock price movements. Then we had a long stretch through the 2010s when fund investors relentlessly sold equity funds and bought fixed income products. Stock buybacks filled the gap, and then some, which is one reason why US stocks delivered excellent returns (13.4 pct CAGR) in that decade.
Granted, we’re talking about a fairly new trend here when it comes to US fund investors actually adding to their domestic equity exposure:
- 2019 saw $169 bn of US equity fund outflows, or $14 bn/month
- 2020 had $282 bn of outflows, or $24 bn/month, and most of this (79 pct) came out during the April – December rally
- But this year has seen $122 bn of inflows into US equity funds, concentrated in February ($45 bn), March ($53 bn) and May ($15 bn)
The latest weekly Investment Company Institute data through June 2nd shows this nascent streak is continuing, with $810 million of US equity inflows in a holiday-shortened period. Even adjusting for the missing day and seasonality, that is well below the trailing 4-week average of $3.7 bn. But flows are still positive, and that’s a win given the longer-run trends we highlighted above.
As for other money flow trends in last week’s data:
- Fixed income funds continue to gather assets in line with recent trends: $10.3 billion last week versus a 4-week average of $11.0 bn.
- Non-US equity fund flows remain robust. Last week’s inflows were $3.5 bn, close to the 4-week average of $4.7 bn when adjusting for the missing day. Year-to-date inflows here actually outpace US fund flows, $144 bn versus $122 bn.
- Commodity funds, mostly dedicated to physical gold, saw another strong week with $1.5 bn of inflows versus a 4-week average of $1.1 bn.
Takeaway (1): lost in all the fascination with retail investor meme stocks is the fact that mutual/exchange traded fund investors have started consistently buying US equity funds for the first time in many years. At the margin this obviously helps stock prices, and the latest data shows this trend is not over yet.
Takeaway (2): as for whether this is a useful contra-indicator since retail investors are supposed to be “dumb money”, frankly the jury is still out on that point. Looking at just the last decade, the answer is clearly “Yes”. Retail sold most of the 2010 – 2019 rally, so their track record is pretty bad. But, linking back to how we started this analysis, we are also respectful of what happens when retail fund flows turn positive and stay that way. Stocks go up – a lot. To adapt an old saying: “dumb money can stay dumb longer than a short seller can stay liquid”.
#2: US large cap Financials (ETF symbol XLF) have been one of our cyclical sector picks this year, and we stuck to that even after long term interest rates peaked in March. That has worked out fine: XLF is up 9.4 pct over the last 3 months, beating the S&P by 1.1 percentage points.
Given that rates are now rolling over, however, we need to revisit this viewpoint.
On the plus side:
- Financials remain the cheapest industry group in the S&P 500, with a 14.9x forward multiple versus 21.1x for the index as a whole.
- Contrary to popular belief, banks are not the majority of the large cap Financials sector. Their current weighting is 39 percent, with Capital Markets (26 pct) and Diversified Financial Services (13 pct) making up an equal proportion of the index.
- That’s important, because bank stocks did stall out when rates began to drop. The S&P Bank Index (KBE) is only up 1.2 pct in the last 3 months, and the S&P Regional Bank Index (KRE) is only +0.7 points over that period.
And the negatives:
- We’re coming into Fed Stress Test season, with results out on June 24th. While most institutions should pass with flying colors – the Pandemic Recession was its own stress test, after all – we will have to wait until after this date for more color on share buyback levels.
- American consumers are still flush with cash and credit card balances are at levels last seen in 2017 ($748 bn, down $109 bn from March 2020). Mortgage rates have bounced back modestly (2.99 pct now, 2.65 pct in early January) but remain well below pre-pandemic lows (3.35 pct in May 2013).
- The whole group sits in an uncomfortable vise, with regulatory pressure on one side and FinTech disruption on the other. At a macro level, this is why the group is the cheapest in the S&P 500. Imagine if department stores had been as heavily regulated as financial institutions when Amazon was expanding over the last decade, and you have the Financials story today.
Takeaway: the pros and cons are evenly balanced, in our view, but we’ll keep our recommendation to overweight the group for two reasons – earnings estimates are too low and sentiment on the group is dreadful. FactSet data (link below) shows that analysts expect the Financials sector to post a decline in earnings next year (-0.9 pct), the only sector where they expect to see down earnings. That makes little sense to us in the context of macro growth. On top of that, the Street sees little upside in the group (just 3.4 percent over the next 12 months versus 13.6 pct for the S&P). Financials, in short, are a contrarian bet with a cheap rate hedge thrown in for good measure.
ICI Money Flow Data: https://www.ici.org/statistics
FactSet Earnings Insight report: https://www.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_060421.pdf