Investors’ flows into risk assets reached a crescendo in mid-February. We are beginning to see dampened demand for global equities and inflation protection, but increased demand for lower beta sectors and even government bonds.
U.S. and foreign equity ETFs managed to gain in-flows last week during amplified volatility. Global and small cap equities remain heavily in favor, while thematic (e.g. ARK funds) losses ground. All in all, anticipation of global synchronized growth supported by fiscal stimulus and vaccines fuels a continued risk-on bias.
On the flip side, investors have sent a mere 25 cents of every dollar of in-flows over the past three months into fixed-income and precious metals.
Demand for broad-based commodity exposure has surged, reaching a record rolling one-month pace of $1.65 billion. Surprisingly, investors appetite has been strong during industrial metals’ tumult over the past two weeks.
Industrials metals and the U.S. dollar index (DXY) have become the most negatively correlated since August 2012. The pair may be headed for a record negative correlation over the days ahead.
Given industrial metals’ tremendous rebound near 50% over the past year, we are concerned any setbacks would only fuel the U.S. dollar.
Investors have shown the strongest demand for energy, financials, materials, and industrials sectors over the past week. Defensive sectors include consumer staples, health care, and utilities remain the odd men out.
Bigger picture, investors are chasing sector-specific equity ETFs unlike any other period in history.
The pressing question is when bullish enthusiasm finally reaches a peak. The spread between rolling three-month flows for equity and government bonds reached a peak on February 9, 2021, just shy of +5 standard deviations. Similar extremes in the past have marked the end of strong risk-on biases.
Away from thematic, investors have also begun to pare flows into global fixed-income assets. The U.S. dollar may not be helping with its recent bounce. We have argued since January 11, 2021, the U.S. dollar is more apt to rally than decline thanks to a likely re-widening in central bank shadow rates over the months ahead.
Inflation protection has become less in demand while nominal bonds have finally gained traction. Investors’ frenetic desire for TIPS over rolling one-month windows has significantly backpedaled since early February. Nonetheless, we would need to see nominal bonds receive greater flows on a relative basis than TIPS to believe the ‘inflation is coming!’ party is ending.
Surprisingly, investors have sent flows into short to intermediate-term governments (i.e. U.S. Treasuries). Deeply oversold conditions and a lack of any in-flows have investors beginning to take the other side. Again, we need to see all maturities join the bullish chorus to believe a trend shift is underway.
Finally, demand for investment grade and high yield corporate bonds remain scant ever since the Fed put an end to 13(3) programs. Now aggregate bond funds have seen diminished demand thanks to the rise in yields across the entirety of fixed-income.