Investors have been pumping money into funds at an unprecedented rate. According to data provider EPFR, during the first half of 2021, $580bn has been added to the equity fund sector. Strategists say that if this rate continues for the rest of the year, it will mean that inflows in 2021 will be higher than the combined totals of the last 20 years.
What Does This Mean For The Stock Market?
Equity funds, flush with cash, have been putting this money in the one place that is producing excellent returns: the stock market. The markets have continued to rise as the pandemic recovery plan continues. Markets are at record highs and are outperforming the expectations of several analysts and big-name institutions.
The S&P 500 is up almost 15%, and the FTSE All-World Index is up by 12%. Even the UK markets, slower to recover from the pandemic crash than the US, are beginning to move north — up about 5% this year.
What Has Caused This Record Fund Investment?
One of the most significant factors in these record numbers is bond yields. Compared to the equity markets, bond yields are producing relatively low returns.
More than $12tn-worth of debt is trading with yields of below zero. With US inflation rates at around 5% for June and UK inflation at 2.1%, bond yields have struggled to keep up. For many investors, this left them with a stark choice: Accept negative real returns on bonds or enter the booming equity market.
Why Are Bond Yields So Low?
On March 31, Treasury yields hit a high of 1.749%. Market optimism was high with the vaccine rollout and pandemic recovery going to plan. Cut to July, and the 10-year Treasury yield is at 1.251%.
The US job market is recovering slower than expected, but overall the economy is recovering faster than the 2008 financial crisis. So why are bond yields so low?
Michael Darda, a strategist at MKM Financial Partners, suggests two reasons. Firstly, the bond market is pricing in a recession during 2022. Current predictions indicate growth of around 4%. However, earning estimates would have to come down if he is correct, meaning the market would take a tumble.
Darda’s second reason is also bad news for the market. He believes that the Fed’s bond-buying and returning money to the Treasury are pulling down rates.
Where is the Bond Yield Money Flowing?
So far, the flows out of bond yields have been directed to global funds and funds that buy American, European, and Japanese stocks. These funds have been pouring into the growth and tech sectors. While inflation is something of concern, this pattern is expected to continue.
Another fact is low-interest rates. The cost of cash is decreasing, and investors are looking for places to use it, and they are choosing broader asset markets.
Value stocks, whose prices are tied to the economic cycle, performed well in recent months. But since inflation expectations increased in May, market rotation has seen the tech sector surge once again. Stock like Apple is up 13% this month.
Another stream that is flowing into funds is from retail investors. Data from Vanda Research’s VandaTrack suggests that first-time traders are active in the market and have invested $28 billion in stocks and exchange-traded funds.
Recent market volatility and significant price rises continue to attract investors who are sure the market will continue to rise.
Where Will The Equity Market Go?
Retail investors’ market optimism is shared by larger institutions like UBS Asset Management, JPMorgan Asset Management, and BlackRock. They all suggest that the equity market will continue to grow throughout the second half of 2021.
As long as bond yields remain low and credit spreads stay at a tight level, the stock market is the most attractive place for investors.
Analysts at Goldman Sachs have suggested that $5.5 trillion is sitting on the sidelines due to the pandemic. They believe that this pent-up demand will further swell the equities market.
As long as interest rates stay low and earnings growth stays positive; the market should remain healthy.
With bond yields failing to beat inflation and the pent-up demand of cash saved during the pandemic being used by institutions and retail investors, funds have seen a record inflow of money.
These investment funds are likely to target high-growth opportunities, in particular, large-cap US companies. As this money flows in, expect the markets to continue their upwards trajectory.
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Alpesh Patel OBE