Concerned about slowing global growth and the protracted U.S.-China trade war, investors pulled more money out of stock funds in 3Q 2019 than in any previous quarter since 2009, per analysis by Morningstar reported by The Wall Street Journal. The net outflow of roughly $60 billion also represented the largest percentage decline in consecutive quarters since 2011. This was a sharp reversal from the same period in 2018, when stock funds enjoyed net inflows of $20 billion.

“Our contention is that there’s going to be a disconnect between expectations and reality,” observes Lisa Shalett, chief investment officer (CIO) at Morgan Stanley's wealth management division, as quoted in another report by the Journal. "You’ll need the trade issue to get resolved,” says Nicholas Colas, founder of DataTrek Research, in the same article. He believes that continued uncertainty over tariffs is bound to reduce corporate hiring and consumer spending.

Key Takeaways

  • 3Q 2019 saw the biggest net outflow from stock funds since 2009.
  • It was the largest percentage decline from the prior quarter since 2011.
  • Slowing economic growth and trade conflicts are spurring the flight.
  • Investors are rotating into bonds and defensive stocks.

Significance for Investors

Morgan Stanley Wealth Management is recommending that investors hold a below average proportion of U.S. stocks in their portfolios. They see growth in the economy and corporate earnings as having “slowed materially this year,” thus limit the upside for stocks in the months ahead, per the Journal.

In the current issue of The GIC Weekly from Morgan Stanley, Shalett notes that 3Q 2019 profits for the S&P 500 are likely to fall by 6% year-over-year, and that EPS will decline to a lesser degree, by about 3.5%, as a result of aggressive share repurchases by companies. She sees these negatives: "Trade talks look unlikely to roll back tariffs already in place. The aggregate impact of the [interest] rate cuts [by the Federal Reserve] has been only about half of what was expected, and the strong-dollar headwind has intensified. At this point, we want to see valuation and catalysts rather than hope for policy change."

Meanwhile, bond funds recorded a net inflow of $118 billion in 3Q 2019, almost twice the figure in 3Q 2018. U.S. money market funds added about $225 billion, of their biggest quarter in nearly a decade, per the same sources.

Additionally, the money that has remained in equities is pivoting towards defensive stocks that offer high dividend yields and low volatility. Partly as a result, utility and real estate stocks have been the best-performing sectors of the S&P 500 over the past month. Moreover, equity ETFs that seek to minimize volatility have been growing in popularity, pulling in about 20 times more funds that growth-oriented funds, according to analysis by Strategas Research Partners cited by the Journal.

"With last week's trade negotiation behind us, we fail to see any meaningful impact on the real economy in the near term," says Morgan Stanley's U.S. equity strategy team led by Mike Wilson, in the current edition of their Weekly Warm Up report. They call it "more of a 'truce' than a deal of notable significance," and predict that "Friday [Oct. 11] should mark near-term highs for [stock market] indices."

Looking Ahead

While a downbeat earnings outlook for 3Q 2019 overhangs the market, October has, on average over the past two decades, delivered the second-best monthly gains for the S&P 500, according to the Stock Trader’s Almanac, as reported by the Journal. Moreover, against a background of monetary stimulus from the Fed, investors may have become too defensive, observes Todd Sohn, director of technical strategy at Strategas, in remarks to the Journal. He believes that a significant turn to the upside in economic data or trade negotiations could spark a sudden shift back into cyclical stocks.

Meanwhile, Goldman Sachs projects that the U.S economy will continue to expand through 2020. Their economists expect that U.S. GDP will grow at an average annualized rate of 2% from now through the end of 2020, per Goldman's current US Weekly Kickstart report.