For much of 2019, the big conundrum facing investors has been justifying the unprecedented divergence between institutional sentiment as represents by historic outflows from equities on one hand, and the market’s honey badger-like ascent to new record highs in 2019 on the other, ignoring the continued redemptions, and propelled higher on the back of record stock buybacks, recurring waves of rolling short squeezes, and dealer gamma positioning.
To some, such as JPMorgan’s Marko Kolanovic, this divergence was to be glossed over as it was only a matter of time before the market skeptics were forced to throw in the towel on the S&P’s way to 3,000 (which Kolanovic predicted in February would be hit by mid-May… it’s now June, and the S&P is back down to 2750).
The JPMorgan strategist’s core argument is ignore what flows are telling you and just follow the price. And yet, a funny thing happened on the way to S&P 3,000: Trump first doubled down on trade war with China… then he escalated the trade war with Mexico, “weaponizing” tariffs as a means to achieve his border policy, and then – last week – he completed the trifecta when he also dragged India to the verge of the global trade war.
As a result, it now appears that all those screaming that “price is always right” were wrong, as was the overall market, and all those bear who found solace in the ongoing found outflows, were right all along.
Which is a problem for the market, because with the S&P having just suffered its third worst month since the US AAA- rating downgrade in August 2011, and its worst May in decades, all those who were already trimming their exposure will now double down, sending their redemption requests into overdrive.
But before we get there, first a recap of where we are now.
According to Deutsche Bank, looking at the latest EPFT data, last week the safety bid in flows continued – as one would predict – with large outflows from equity (-$10bn) and HY (-$3bn) funds, but inflows to other bond (+$10bn) and money-market funds (+$12.9bn).
And here, a shocker: equity funds have now seen outflows of -$132bn YTD and -$237bn since December. This means that outflows over the last 6 months in dollar terms have now been larger than over any prior 6-month period.
As a percentage of AUM, the latest half-year outflows were only exceeded by those seen around the 2008-09 recession and the European financial crisis.
Breaking down the flows geographically: the US saw -$8.4bn in outflows, Europe -$1.8bn and Asia ex Japan -$1.7b), while Japan attracted $1.9b in inflows. Broad-based global funds (-$0.3b), global EM funds (-$0.1b) and Latam (-$0.1b), too, saw outflows although at moderate pace. European equity outflows were at their slowest pace in 16 weeks, and were driven both by domestic (-$1.3b) and foreign (-$0.5b) flows. In Japan, on the other hand, domestic investors pumped in $2.4b, while foreign investors pulled out -$0.4b. China funds saw outflows continue (-$1.7b) as it continues to bear the brunt of trade concerns, while India funds got their biggest inflows ($0.3b) since early 2018 after the election results showed a strong renewed mandate for the incumbent administration.
By contrast, bond funds have seen inflows of $220bn ytd…
… close to the largest on record over comparable periods in the past, and money-market funds have seen inflows of over $107bn just in the last 5 weeks, in what is usually a seasonally weak period.
And, as Deutsche Bank confirms what we have been saying through this entire rally, “With trade tensions ratcheting higher yesterday we are likely to see the safety bid strengthen further.”
So now that the selling avalanche is now just a matter of when, not if, Deutsche Bank provides some observations on which will be the first investor classes to capitulate:
Vol Control funds will remain sellers as vol rises on the latest selloff. Since the end of April, Vol Control funds have sold net $13-$15bn in equity exposure and if the S&P 500 were to sell-off an additional -2% on Monday, they would have another modest $5-7bn to sell. And since allocations still remain on the higher side, DB warns that the risk is asymmetric to the downside.
CTAs also have begun selling as near-term triggers are hit. According to DB, the CTA complex is net long S&P 500, but with lighter positioning versus 2018 sell-offs. Additional selling likely if short-term MAs cross long-term MAs, which requires spot to stay low for the next few weeks.
Risk Parity funds have mostly not reacted to the sell-off yet – as thesestrategies are slow moving – but do have significant beta to the S&P 500. It is possible that some PMs with more discretion de-risked, but most have significant beta to the S&P 500… right as the sell-off is hitting. With 1M vol of the cross asset portfolio only at 5, the negative correlation between equities and bonds continues to offset some of the pick-up in equity volatility
Away from systematic funds, traditional equity L/S is only down -2% in May…
… with low net and gross exposure going into this sell-off (once again, not many appear to have listened to the JPMorgan quant). YTD returns are +4.9%, off from a high of +7%.
Popular single-stock longs have performed in-line with popular single-stock shorts, while the recent Momentum rally has not significantly impacted returns given the Hedge Fund complex’s relatively flat exposure to the factor.
So as the equity outflows continue, it appears that all those who were betting that longs on the fence and who would be forced to jump in kicking and screaming, were wrong. The only question now is how much of a drop is expected before we finally do see some inflows…. unless of course, there is no catalyst that can take place to change the current status quo – and with both the Fed’s reversal and China’s record credit injection now in the rearview mirror, one wonders just what will prompt a turnaround to the fund flow direction – in which case global capital markets are about to face a historic day of reckoning.