Last week we reported that for the first time since the election, Bank of America's smart money clients were, as a group, selling stocks. As BofA's Jill Carey Hall calculated, after significant buying over the past few weeks, net client sales of $2.1 billion were the largest since June. However, there was a further nuance, one which has emerged as troubling for those calling for sustained gains in the market.
As the following chart shows, while Private Clients, aka high net worth retail investors, have been on a furious buying spreed unlike anything seen in the past decade (green area chart below), prominent institutional clients have skipped the Trump rally altogether and have been net sellers for the past 12 months, with hedge funds joining in over the last few weeks.
Now, in the latest report by JPM's Nikolaos Panigirtzoglou - who writes the popular weekly "Flows & Liquidity" report - he confirms that the latest "Great Rotation" is one not from bonds into stocks, but from "smart money" to retail investors who have finally joined in the market euphoria, traditionally seen as a topping sign for rallies.
According to JPM, confirming the ongoing troubles plaguing the active investor community (which was slammed most recently by none other than Warren Buffett who in his annual letter praised passive investing, called Jack Bogle a "hero", and lashed out at hedge funds), YTD $83bn has been invested into equity ETFs while $15bn got out of active equity mutual funds. This not only means that the shift away from active funds continues unabated but also that the overall retail flow into equity markets is accelerating. JPM estimates that around $50bn-$100bn was invested into equity funds last year. The $68bninvested into equity funds on net YTD implies an annualized flow of $442bn, almost six times larger than last year’s pace.
Panigirtzoglou adds that while the vast majority of the YTD ETF flows went into large unlevered equity index ETFs, leveraged ETFs amplified the equity market rally also via rebalancing flows “enforced” by daily market moves. This is shown in Figure 2 which shows the daily capital and rebalancing flows by leveraged equity ETFs. While on average leveraged equity ETFs saw a capital outflow YTD, their rebalancing flows were very positive, cumulatively effectively amplifying the equity rally by $7bn since the beginning of the year.
Yet while retail investors have been flooding into ETFs, institutions and hedge funds are doing something very different: they are selling.
Confirming what BofA observed last week, JPM writes that in contrast to retail investors, institutional investors appear to have overall reduced rather than increased their equity exposure YTD. Figure 3 shows the betas of various types of institutional investors by month. While for February the betas are based on the performance of daily reporting hedge fund funds, for previous months we use the more comprehensive monthly hedge fund indices. These monthly performance indices are not yet available for February.
The picture we get from Figure 3 is of only CTAs raising their equity beta in February, reversing the January decline. Adding to the market dynamics, it is likely that as in the case of the Catalyst fund whose forced buying of S&P futures was profiled here two weeks ago, many of the CTAs may be simply caught in a "gamma trap", and are forced to cover synthetic shorts, pushing the S&P higher, in turn forcing even more short covering in a feedback loop that levitates the market to record highs despite ever growing concerns about the implementation of Trump economic policies.
And, as JPM notes, in contrast to CTAs, equity Long/Short hedge funds, Risk Parity funds, and Balanced Mutual funds appear to have all lowered their beta in February vs. the previous month. Currency hedge funds appear to have increased their beta in February, but this represents the beta to the dollar only, rather than the beta to equities, so this currency hedge fund beta does not reflect equity exposures.
Furthermore, in terms of YTD beta changes, i.e. by comparing the February beta vs the beta of last December, CTAs and Equity Long/Short are flat, while Macro ex CTAs hedge funds, Risk Parity funds and Balanced Mutual funds are down. So the picture we get is of institutional investors either lowering their equity exposure YTD or keeping it unchanged.
"This apparent unwillingness by institutional investors to raise their equity exposures YTD reinforces the argument that it is retail rather than institutional investors that most likely drove this year’s strong inflows into equity ETFs and as a result this year’s equity rally."
There are several implications from these findings.
The first is that with ETFs the dominant vehicle of expressing market sentiment at this moment - almost excluslively by retail investors - it means that certain distinct market "aberations" have become an odd fixture of the market, such as the now daily market ramp in the last 30 minutes of trading, which was on display most recently on Friday when as we discussed, a last minute burst of buying pushed the S&P not only to the green, but sent the Dow Jones to a new all time high just 7 seconds before the close of trading.
We will have more on this in a subsequent post.
The other obvious finding is that the vast majority of professional, active investors and asset managers are taking advantage of the current market rally to sell risk and offload exposure to retail investors, who remain in the driver seat and provide ever higher prices against which to sell.
How long this unstable equilibrium persists is unclear, and JPM refuses to make any predictions. However, with the fate of the market, now hitting record highs in the longest streak since 1987, it won't take much to spook "mom and pop" daytraders and halt the ETF bid, resulting in the first market selloff under the Trump administration. We wonder what Trump, who has repeatedly pointed to the market's outperformance as an indication of his successful policies, will say once the S&P prints its first correction (or bear market) under his watch.