A sharp reversal in the markets is taking place as the Federal Reserve weighs cutting interest rates again this week to bolster the economy and markets, which are trading near historic highs. "The gap between US equity fund flows relative to bond and cash funds during the past 12 months is the widest since 2008," says Goldman Sachs in its latest US Weekly Kickstart report.
Even more sobering, Goldman says the market is on track in 2019 to record the second-largest net outflows from U.S equities in 15 years.
"Decelerating US economic growth, trade and geopolitical uncertainty, and near-record high starting equity allocations have likely contributed to the rotation from equities to bonds and cash this year," the report says. "Although the S&P 500 is almost back to its record high, investor risk appetite appears lower now than it was a year ago."
Significance For Investors
U.S.-based equity mutual funds and ETFs have seen a combined outflow of about $100 billion for the year-to-date through Oct. 24, 2019, says Goldman. Hardest hit have been actively managed U.S. equity mutual funds, with net outflows of $217 billion. Partially offsetting this has been a net inflow of $117 billion to passive funds.
- Investors are fleeing U.S. equity funds for bonds and cash.
- Equity allocations are still at historic highs.
- Actively managed equity funds are seeing the biggest outflows.
- Passive equity funds are enjoying inflows, however.
Meanwhile, bond funds have taken in a net $353 billion in additional assets, while cash funds have received $436 billion in net new investments. The rotation from equities to cash may be far from over, based on historic allocations, Goldman notes.
The shift in fund flows appears less extreme from a historical perspective. While the aggregate share of equities in investors' portfolios has dropped from 46% one year ago to 44% today, that still ranks in the 81st percentile since 1990. The aggregate allocation to bonds is up from 24% a year ago to 26% today, but still ranking only in the 50th percentile since 1990. The overall allocation to cash is now 12%, but that also is still relatively low, in just the 5th percentile historically.
Goldman observes that all the major categories of investors have increased their allocations to cash during the past 12 months, which includes households (retail investors), mutual funds, pension funds, and foreign investors. Collectively, these categories represent 84% of the equity market.
Despite this, Goldman concludes that "equity exposures are not extreme," and they expect equity allocations to remain "relatively stable" in 2020. They project that corporations, households, foreign investors, and ETFs will be net buyers of stocks in 2020, but mutual funds and pension funds to be net sellers.
A key driver of the bull market has been corporate share repurchases, the biggest source of demand for stocks during its decade-long run. Goldman projects that net stock buybacks will decline by 2% in 2020, to $470 billion, amid falling corporate cash balances, slowing EPS growth, and rising political scrutiny.
To be sure, the S&P 500 is up by 21% so far in 2019, but those gains were mostly in the first four months of the year, and the index has remained within a narrow trading range since early 2018, The Wall Street Journal observes. Indeed, the close on Oct. 25 was just 5.2% above the high point in intraday trading on Jan. 26, 2018. Moreover, through Friday the index has gone 64 trading days without setting a new record high, the fifth-longest such drought in the past five years.
"At the first sign of trouble, we could head lower because what we have is a very tenuous trade pact," as Meghan Shue, chief investment strategist at Wilmington Trust, told the Journal. Adam Phillips, director of portfolio strategy at EP Wealth Advisors, agrees. "We really need progress on trade. That's what's really going to restore business sentiment and restore capital spending," he remarked to Journal.