The bigger the equity fund outflow, the better the outperformance of the market. Or so it seems based on ICI data. Last week posted the 13th straight equity fund outflow since the beginning of August: the total outflows amount to over $36 billion, and yet the S&P has increased by over 11% over the time period! With ever decreasing relative volume, and thus an ever increasing impact of the marginal purchaser, the question of who on earth is buying should be addressed to 33 Liberty Street, Floor 9.
The chart below is indicative of the market action since early August, together with what investors (not to mention insiders) thing about this rally.
And some observations on rally participation from Rosenberg:
THE PUBLIC REFUSES TO CAPITULATE
Once again, we are being treated to a real-life lesson on human behaviour as it pertains to resolve. Instead of treating a 65% equity market rally from the lows as a source of frustration at how the train could have left the station so quickly and as reason to join the leveraged hedge-fund herd, Ma and Pa Kettle are looking at this bull run as a gift from the heavens for they seem to be using the rally as an opportunity to lighten up on their positions. After all, if I had asked anyone at the March lows if they would accept my offer to take them up out of their equity position at a 65% premium but they had to aqree never to go long the market again, I wonder how many “it’s yours!” responses I would have garnered.
The reality from the Fed Flow-of-Funds data is that U.S. households have just 7% representation of fixed income in their asset mix but over 25% in equities (and still over 30% in real estate, if you can believe it). So, what we have on our hands is a conscious effort on the part of individual investors — remember, households have a $55 trillion balance sheet — to rebalance their mix of investments. So, for all the talk of “dry powder” (money market fund assets plunged $8bln last week) — it is being increasingly diverted towards income-generating securities, and we identified this as a secular behavioural theme, well, ages ago to be frank. What do we see in the data? Households were net redeemers in equity funds to the tune of $1.24 billion in the week ending November 11 — brining the cumulative outflow to $6.8 billion over the past three weeks. And what do you know? Bond funds of all types attracted 8.9 billion of new inflows last week, on top of $7.5bln the week before. Hybrid funds also took in a net $782 million last week.
And something off topic, again from Rosie, which bears pointing out, especially for all those who doubt that the i) dollar is now a massive carry trade windsock, and that ii) when the trend inevitably turns, there will be hell to pay.
Besides a double-dip recession, there are the obvious risks of another credit collapse. However, with the level of government support out there and pledges by the Fed, G20 and APEC (Asia-Pacific Economic Cooperation) to keep policy extremely accommodative, the odds of an early ‘exit strategy’ like we saw in 1937-38 and in Japan in 1996-97 seem remote.
If there is a non-economic risk, it comes down to the U.S. dollar, and Nouriel Roubini is probably onto something in the sense that it has become a huge ‘carry trade’ vehicle for all risky assets. Historically, there is no correlation at all between the DXY index (the U.S. dollar index) and the S&P 500. In the past eight months, that correlation is 90%. Ditto for credit spreads — zero correlation from 1995 to 2008, but now it has surged to 90% since April. There was historically a 70% inverse correlation between the U.S. dollar and emerging markets, such as the Brazilian Bovespa, and that correlation has also increased to 90% since the spring. Even the VIX index, which historically has had no better than a 20% correlation with the U.S. dollar, has now sent that correlation surge to 90%. Amazing. The inverse correlations between the U.S. dollar and gold and the U.S. dollar and commodities were always strong, but these too have strengthened and now stand at over 90%.
The bear U.S. dollar trade is very crowded right now. Mr. Bernanke mentioned the dollar’s weakness yesterday as a possible source of concern — it is very rare to see that from the Fed. It’s hard to know what the catalyst for a near-term counter-trend rally would be (one catalyst could be an “event” in China, and for an example, see Big Property Bubble Forming in China, Warns Leading Developer on the front page of today's FT) but that is a primary near-term risk and the only reason I can see for keeping our powder dry. Recall that in the fall of 1987, it was a sharply weaker (and disorderly) U.S. dollar in the aftermath of the failed Louvre Accord that ultimately touched off the crash (Baa spreads widened over 100bps in a week — despite GDP growth of over 7%). So, big and sudden moves in the U.S. dollar have in the past been a catalyst for big market moves and something that has to be taken into consideration if we are looking at all into raising our risk profile/leverage in this space.