Equity price action suggests economic slowdown concerns could be overblown
April got off to decent start for stock bulls, with the S&P 500 Index (SPX - 2,892.74) tallying its second consecutive week of gains and its 12th weekly gain in the last 15 weeks. A positive April would make it four consecutive months of gains, which hasn't occurred since July 2018.
Despite the SPX displaying a 15.4% year-to-date (YTD) gain, investors have not been chasing the rally like one might expect. In case you missed the Reuters excerpt that I included in last week's commentary, I reproduced it immediately below. The emphasis is mine, and gives perspective on how puny stock inflows have been relative to bonds in 2019.
"...U.S. investors added a net of $14.2 billion into domestic stock funds over the last two weeks, the most over a two-week span since the net $17.4 billion invested in late January 2018. Domestic stock funds have brought in a net of $715 million over the 11 full weeks of the year to date... World stock funds, meanwhile, continued a five-week streak of shedding assets, dropping a net of $3.6 billion last week... For the year to date, world stock funds have brought in a net of $4.4 billion... Bond funds overall added a net of $10.6 billion in assets last week, continuing a streak of positive inflows over every full week of 2019. Since the start of January, bond funds have garnered a net of $104.1 billion."
-- Reuters, March 27, 2019
"Taxable bond funds (+$3.7 billion) took in the most net new money, while money market funds (+$1.4 billion) and municipal debt funds (+$714 million) also contributed to the net positive flows. Equity funds (-$3.9 billion) were the lone asset group to experience net outflows."
-- Lipper Alpha Insight, April 5, 2019
The inflow data suggests that most investors are still embracing a slower growth scenario, despite headlines indicating trade talks are progressing with China and a Fed that appears to have taken a more accommodative stance relative to what it was signaling in late 2018.
Judging by the price action in equity markets, consensus concerns about a slowdown could be overblown. The question in the immediate days ahead is whether fund flow data begins to favor outperforming equities. In the week ended April 3, bond funds saw inflows -- building on the huge inflows in 2019 already -- while equity funds saw outflows.
Clearly, there is a group of investors missing out on the advance in the equity market, as outflows from stock funds totaled more than $50 billion in the fourth quarter of 2018 and inflows have been only $4 billion, and less than $1 billion of that for U.S. stock funds.
To the extent that the cash that was removed from stock funds in late 2018 (and even last week) represents potential fuel in the months ahead, stock market bulls should feel good about the ever-present caution as stocks continue to march higher. Perhaps it will take a string of better-than-expected economic reports, like we saw on Friday with the employment data, before equity fund inflows begin to dominate bond inflows.
On the technical front, potential equity investors may need more convincing, even following the SPX's breakout above the highly watched 2,800 level a few weeks ago. The SPX finds itself just below another round number, 2,900, with its all-time closing high in September 2018 at 2,930 lurking just above. This could set up action like we saw from February into late March, in which the SPX ran up to the 2,800 level after a breakout above a trendline connecting the early October and early December highs. But it took more than a month for the SPX to finally make a clean break of 2,800.
History suggests that a run through 2,900 and back to the September intraday high of 2,940 is imminent. Since 1950, in the 11 instances in which the SPX experienced at least a 20% decline from intraday high to intraday low, as it did in the fourth quarter, and then rallied back to within 2% of its intraday high, which occurred on Friday when the SPX closed above 2,882.09, the previous intraday high was touched on nine of those occasions within 33 calendar days.
There are groups of traders that could push the SPX up to and potentially through potential resistance overhead, particularly those feeling the pain in the current rally. For example, check out the net positioning of large speculators in the E-mini S&P futures contract, who were still net short in mid-March as the SPX was toying with 2,800. This group is now net long, per the latest Commitments of Traders (CoT) report, but the net long position is 85% below that of November 2018, when this group was extremely bullish coincident with the SPX failing at 2,800.
Another chart that I find interesting is total short interest on SPX components, which you can find immediately below. The most recent data, as of mid-March, showed short interest hit a multi-month high. With the SPX up 12.5% YTD as of mid-March, short interest increased 3% during this period. Many of these freshly added positions are likely underwater, and an unwinding of this trade could be another source of fuel in the weeks ahead.
As I said last week, the risk to the current rally is the positioning of large speculators on Cboe Volatility Index (VIX - 12.82) futures, who are now at their most extreme net short position on volatility since November 2017. There is likely more risk than reward in this trade, but it is a trade that may not blow up again until we see extreme optimism surface among other market participants.
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