Last month, stocks shrugged off plenty of pessimistic data and profit reports to surge higher — with the S&P 500 Index climbing 8.3% in October — the best monthly gain in four years.
That’s a stunning reversal of fortune considering the dismal economy and depressing corporate results this quarter.
In fact, third-quarter GDP shows the U.S. economy slowing to a crawl, growing at a yearly pace of just 1.5% — less than half the growth of the previous quarter. Corporate profit reports have been equally demoralizing with 53% of stocks in the S&P 1500 Index reporting top-line sales that missed estimates. S&P profits are on track to fall more than 2% year over year, the second straight quarterly decline in earnings, which is a major red flag for me.
Still, you would never know it by the way stocks zoomed higher last month and new highs are now in sight. In fact, the S&P 500 is just 35 points away from its May peak! So, which stocks and sectors are investors flocking to, driving the market higher? The answer is twofold:
1. The return of an old familiar theme, and
2. Major reversals of fortune for the market’s biggest winners and losers.
I like to take a close look at ETF money flows on a monthly basis for evidence of new buying and selling trends. Because low-cost ETFs have grown so popular among investors, they’re a pretty good proxy for overall capital flows in global financial markets.
And here’s an interesting trend that re-emerged last month after being dormant in August and September: Global capital flows into U.S. stocks and out of International stocks.
Dr. Martin Weiss has highlighted this theme many times in the past year: the global tsunami of money flowing out of troubled economies in Europe, the Middle East and elsewhere, and seeking out safe-haven investments in higher quality U.S. assets.
Well, this theme played out in spades again last month with U.S. stock and bond ETFs attracting over $20 billion in fresh capital during October according to Bloomberg data.
Some $10.7 billion in capital flowed into U.S. equity ETFs last month alone. That’s a sharp acceleration in money flows to domestic stocks, up from the $6 billion of total inflows so far in 2015 through the end of September.
But it’s not just stocks that investors have a renewed appetite for: U.S. corporate bond ETFs enjoyed inflows of $8.3 billion in October — the biggest single-month of money flow ever recorded.
Most of that cash was attracted to the riskiest bonds, which also offer the highest yields in a world of near-zero interest rates. SPDR Barclays High Yield Bond ETF (JNK) attracted $2.7 billion in assets — the most of any ETF last month — while iShares iBoxx High Yield Corp. Bond ETF (HYG) took in another $5.6 billion in assets.
That’s a big shift in investor sentiment from risk-off in August and September, to a big time risk-on bet again last month.
In terms of stock market sectors, ETFs tracking consumer staples, technology and real estate had inflows of over $1 billion each last month. Tech and staples have been consistently strong performing sectors over the past 12 months, up 11.2% and 9.4%, respectively, and it looks like that trend is continuing into November.
In a stunning reversal of fortune, investors yanked $1.2 billion out of health-care ETFs, that’s after record inflows of $9.1 billion through the end of September. iShares Nasdaq Biotechnology ETF (IBB) accounted for $514 million of the outflow.
You can chock up this asset allocation U-turn to recent comments from presidential candidates about regulating pharmaceutical prices.
Internationally, Germany was one of the biggest losers with investors pulling $600 million out of ETFs that invest in Europe’s largest economy. iShares MSCI Germany ETF (EWG) suffered $354 million of those withdrawals.
Perhaps it’s no coincidence the euro currency was also sliding lower against the dollar last month. But investors also sold $191 billion worth of the iShares Currency Hedged MSCI Germany ETF (HEWG) in October. So this may be more of a vote of no-confidence in Europe’s anemic economies.
And it looks like European capital outflows are bound for U.S. stocks again.
And there was a positive reversal-of-fortune in favor of Emerging Markets in the ETF flow show last month.
After 12 months of steady outflows to the tune of $7.2 billion in withdrawals, emerging market equity ETFs attracted $1.6 billion in fresh capital last month. This could be just the start of a key reversal that reinforces the risk-on theme in financial markets since the beginning of October.
There are several asset allocation trends to keep a watchful eye on here:
#1: U.S. assets, both stocks and bonds, are once again seen as the best game in town for investors in a world where deflation still has the upper hand and growth is hard to come by, and
#2: Emerging-market ETFs and stocks could emerge as big winners if the money-flow trend persists because these stock markets are among the cheapest in the world, making them even more attractive.
The iShares MSCI Emerging Market ETF (EEM) trades at a Price/Earnings (P/E) ratio of just 11, compared with a P/E ratio of 18 for the SPDR S&P 500 ETF (SPY). That’s a very compelling discount for markets that are growing much faster than the U.S.