August 24, 2018 / 2:00 PM / a month ago

'Old' bull market sputters on while tech inflows slow: BAML

LONDON (Reuters) - Investors bought back into U.S. stocks this week which set their longest-ever market rally, although risks ahead spurred anxiety over how much longer the ageing bull can last, Bank of America Merrill Lynch strategists said on Friday.

Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., August 23, 2018. REUTERS/Brendan McDermid

They also declared the end of a “tsunami” of tech fund inflows which have driven the market higher, noting tiny inflows of $0.1 billion this week after a huge $22 billion plowed into tech year-to-date.

Some $2.6 billion flowed into equities funds and $0.5 billion left bond funds as investors’ risk appetite recovered slightly, while $1.2 billion flooded out of gold funds, strategists said, using figures from flows data provider EPFR.

The S&P 500 .SPX extended its bull run to 3,453 days on Wednesday, the longest such streak in history by calculations which set the rally's birth at March 9, 2009.

BAML strategists, however, weren’t particularly impressed, dubbing it an “old, deflationary, polarized U.S. bull” in a note titled “The Old Bull and the Sea” in a nod to Ernest Hemingway’s classic.

They argued the S&P 500 is narrow, dominated by Facebook, Amazon, Apple, Microsoft and Google whose total market cap of around $4.1 trillion is greater than the combined market cap of the smallest 283 stocks in the index.

Still, overall inflows this week indicated a hesitant return to risk and BAML’s “Bull & Bear” indicator of market sentiment drifted up to 3.3 this week from 3 last week.

“Late summer sentiment slowly drifts from bearish toward neutral,” strategists noted.

U.S. equity funds drew in $4.1 billion, leading other regions by far as outstanding earnings growth, spurred by tax cuts, set U.S. stocks apart.

European equity funds suffered a 24th straight week of outflows, losing $1.1 billion. Since March they have given back all $51 billion of the inflows of 2016 to 2018, strategists noted.

Emerging markets, in contrast, have not seen outflows as severe as that, with less than 20 percent of EM debt and equity inflows over 2016-2018 redeemed in the past four months, BAML strategists found.

This week investors pulled just $0.1 billion from EM stocks, while EM debt saw its biggest outflows in eight weeks ($1.6 billion).

Outside tech, sector flows showed a distinct preference for “defensive” high dividend, strong earning sectors with inflows to real estate, healthcare and utilities. Cycle-sensitive financials, energy and materials sectors saw outflows.

In debt markets, flows into investment-grade bond funds picked up again with $0.5 billion, while high-yield bond outflows lessened, losing just $0.5 billion.

Gold is a contrarian buy, strategists suggested, after funds invested in the precious metal saw their biggest outflows since December 2016 this week, bringing outflows over the past three months to $7 billion.

HOT AUTUMN FOR MARKETS

This autumn presents a fork in the road for markets - with the possibility of severe negative shocks as well as a more positive path.

Credit contagion caused by monetary tightening, excess debt and a peak in the profit cycle could cause widening spreads in EM debt to hit European high yield and U.S. investment grade, strategists said, recommending a short in high-yield bonds in this scenario.

A second possible shock could come from an autumn of “hardball politics”, they said, with Brexit developments, Italy’s budget, and China-U.S. trade disputes weighing on global purchasing managers’ surveys and earnings forecasts.

A sweep by Democrats in mid-term elections could spur a switch to “populist redistribution”, they predicted, for example tightening stock buyback regulation. The best trade in that eventuality would be to short U.S. tech, they said.

Among positive catalysts a peak in U.S. inflation, the U.S. 10-year bond yield edging below 2.5 percent, and China stimulus could help drive EM and European earnings estimates higher, in which case investors should hold EM and European banks.

An acceleration in U.S. stock buybacks would also help spur markets, providing a new injection of liquidity akin to quantitative easing, strategists said.

In 2018 so far 35 percent of U.S. profits are being spent on buybacks - not far from the peak of 38 percent in 2007.

Reporting by Helen Reid; Editing by Susan Fenton

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