Huge US equity fund inflows provide clues after market sell-off

<p>It was one of those Fridays (1st August). In Europe, the US and Asia, a sell-off that began a day earlier continued, giving investors and […]</p>

It was one of those Fridays (1st August).

In Europe, the US and Asia, a sell-off that began a day earlier continued, giving investors and traders one of the handful of pauses for reflection they’ve had during a bull market that has spanned more than five years.

The S&P 500 Index and Dow Jones Industrial Average (DJIA) suffered significant two-day losses, with the DJIA notching-up a cumulative fall of around 470 points – losing 2% on Thursday (31st July) and 0.4% on Friday and putting it slightly into negative territory for the year. The S&P 500, meanwhile, lost a similar total of 2.2 percentage points over the two days.

The US market wasn’t alone in getting the heebie-jeebies, of course. Europe’s Euro Stoxx 50 Index of the bloc’s most highly capitalised companies, the UK’s benchmark FTSE 100 and Japan’s main stock index, the Nikkei 225, also posted large reductions of value into the end of the week.

On Monday 4th August, there are signs that confidence is returning to investor sentiment, with the broader FTSE Eurofirst 300 Index of European stocks edging slightly higher at the time of writing, although that follows a fall of about 3% last week.

The cause of the sell-off may not be clear, but equity fund investors were big buyers

As for what triggered the sell-off, there’s a choice of two major tacks.

One can reason that either the stock market rout stemmed from a confluence of geopolitical events that coalesced into a hefty bearish weight in recent weeks—Ukraine, Gaza, Argentina’s default—or it’s possible to just rationalise that major stock markets have been ripe for a correction for ages, following multi-year highs.

However, deciding if the sell-off of the last few days is a short-term blip or the start of a deeper pullback is of course the type of puzzle that occupies the minds of thousands of number-crunching analysts for hundreds of hours on end.

Naturally, their efforts are no guarantee of the accuracy rate of their forecasts.

Even so, it’s possible to get quite a good idea about global stock market momentum by scrutinising the behaviour of large-scale investors. For instance investors in two classes of funds which have enormous flows even just on a weekly basis – mutual funds and exchange traded funds (ETFs).

Contrary to what you might expect, investors in big funds do not appear to be running for the hills, according to data from investment fund information provider Lipper.

Whilst the latest data only goes up to the week ending 30th July, the major geopolitical risk factors currently influencing the markets were already well in play during that period and many have since shown signs of improvement.

Investors in the US-based funds poured a net $7.6bn into stock funds in the week ended 30th July on optimism that US stocks could climb further, Lipper said last Thursday (31st July).

The net inflows were the biggest in seven weeks and reversed net outflows of $7.6bn seen in the prior week. All of the inflows went into exchange-traded funds, which attracted $7.9bn, while mutual funds posted $303 million in outflows.

ETFs are thought to represent the behaviour of institutional investors, who tend to take huge positions and therefore have a major impact on the markets. Mutual funds are commonly purchased by retail investors.

“Expectations are that earnings are going to improve in coming quarters,” said Barry Fennell, senior research analyst at Lipper.

VIX Index spiked, but remains contained in long-term downtrend

It’s also interesting to note the recent behaviour of the Chicago Board Option Exchange’s Market Volatility Index, which purports to forecast the volatility coming in the S&P 500 stock Index over the next 30 days.

Whilst the so-called ‘fear gauge’ has spiked sharply upwards in recent days, zooming out to a longer-term picture shows the index remains relatively contained in a two-year downtrend.

The VIX has respected resistance levels more than a dozen times during that period.

That’s not to say the VIX will definitely ease back from its latest spike too.

But the odds do seem to favour just that. Especially amid signs of a cool-off in the world’s hotspots, like Gaza, after Israel announced a unilateral ceasefire on Monday (4th August) whilst signalling its ground offensive in the region was coming to a close.

Similarly, European stocks also appeared to be rebounding, with the Euro Stoxx 50 Index trading 0.7% higher at the time of writing and the FTSE 100 Index trading 0.4% higher.

Gains were seen across the UK’s banking sector, which bore the brunt of last week’s selling.

Lloyds Banking Group was up 1.7%, Royal Bank 1.3% firmer, and Barclays up 1.2%.

Of this group, Barclays is by far the most discounted relative to the British sector, with a projected enterprise value to sales ratio for the next 12 months more than 37% lower than its peers.

Other sectors rebounding were the energy sector, including BP, as investors appeared to come to terms with the company’s warning that its operations in Russia could be hampered by the situation in Ukraine.

The healthcare and pharmaceutical sector was also firmer. GlaxoSmithKline rose the most, with a 2% gain. It has bounced decisively from a recent six-year low plus the psychologically important 1400p mark.

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