The 60/40 portfolio is off to a good start, as bonds posted gains and global stocks rallied 7.1% in January. As a result, ETFs had $40 billion of inflows, nearly double January’s historical average. Flows were led by the $21 billion into non-US equities (ninth-best ever); US equities had outflows. Meanwhile, bond ETFs added $20 billion of inflows, led by the $7 billion into investment-grade (IG) corporates (third-best ever).
If goldfish have short memories and elephants have long ones, investors need to be part goldfish and part elephant. The goldfish portion helps avoid recency bias and anchoring to the most recent trend or “hot-dot.” It also helps with not fixating on a few days of negative returns. It’s the same concept I relay to my third grade soccer team after the opposing team scores — shake it off and get back in the game (thanks, Ted Lasso).
The elephant side allows investors to stick to their long-term plan by recalling fundamental portfolio construction beliefs. This ranges from rebalancing programs that prevent kneejerk market timing reactions to strategic asset allocation frameworks that let diversification do the heavy lifting during times of market stress.
Balancing goldfish and elephant cognitive thought processes is the trick. Too much goldfish, and investors miss red flags or are unaware that a new trend could have staying power. Goldfish-only investors likely missed how consistent aggressive rate hikes impacted both stocks and bonds last year — and didn’t move fast enough to alter their allocations. Too much elephant, and investors don’t budge off their first principles and become inflexible. For example, they mistakenly believe that they can always rely on a Federal Reserve (Fed) Put.
But investors have kicked off 2023 as goldfish, forgetting the poor returns across asset classes in 2022 and the Fed’s resolve to keep hiking rates to tame inflation. As a result, January inflows were well above their average.
As a result of seasonal effects largely stemming from tax-motivated behavior in equity exposures, January is typically a subdued month for flows. In fact, the 10-year average for January inflows is just $23 billion, the lowest total of any month.
Driven by gains in both stocks and bonds following a dour 2022, where both asset classes fell double digits, January flows got off to a better-than-average start — taking in $40 billion, almost double the monthly average, as shown below.
The above average flows were driven by heighted interest in non-US equities, and for good reason. Relative to US equities, non-US stocks are on their best three-month run since the Global Financial Crisis. In fact, their 13% outperformance over the past three months ranks in the 99th percentile over 20 years.1
A weakening US dollar, fewer downside earnings revisions, China’s re-opening, and more attractive valuations are driving this performance trend. This is investors activating their elephant synapses to recall how liquidity, attractive fundamentals, and macro tailwinds support performance.
Accordingly, international regional ETFs had $5 billion of inflows in January, their most all-time for a month. Regional funds led the non-US equity category with $21 billion of inflows, their ninth-best month ever.
Single-country funds (led by China’s $2 billion of inflows, the fourth-best month ever as investors are finally waking up to a potential rebound) had their fifth-best month ever (+$4 billion). And emerging market (EM) funds added another $5 billion, ranking in the historical 97th percentile.
All this occurred as US-focused exposures posted outflows for the first time since April 2022. As a result, the short-term trend has begun to favor non-US exposures, as shown below. On a trailing three-month basis, non-US is now outpacing the US for the first time since 2019 in a material way. But despite the strong recent trend, flows over the past year for non-US exposures remain almost $200 billion below that of US equities — indicating the non-US trade is not yet crowded.
Sector flows were flat in January, as investors rotated heavily away from Defensives (-$894 million) and lightly into Cyclicals (+249 million). The latter was driven by the $1.4 billion of inflows into the Materials sector, a segment that started the year with some of the more constructive sector valuations. However, the uptick in flows did coincide with an increase in short interest.
Outflows in Real Estate, Financials, and Energy brought the headline cyclical sector flow lower. Yet, this was the first month where Cyclicals outpaced Defensives in more than a year. However, six out of the 11 sectors had outflows, led by the $1.1 billion rotation out of Health Care. And those outflows are a reversal of the prior three-month and 12-month trends, as shown below.
The bias toward Cyclicals is a burgeoning trend over the past three months, as shown below. On a rolling three-month basis, while the figure was still negative, the difference between Cyclical and Defensive flows was closing.
Given the inflows in January into Cyclicals and the outflows from Defensives, the latest rolling-three month figure turned positive for the first time since January of 2022, before the market turned risk-off. As the Cyclical flows were driven by what appears to be not entirely just long-only positions in the Materials sector, the sustainability of this trend may be short lived.
From a bond sector perspective, investors extended duration. The government maturity flows depict this, as does the heavy allocation to IG corporates, as the lion’s share of the inflows went to exposures with a duration north of eight years.
There was also noticeable interest within government funds again this month (+$5.4 billion) — a continuation from the trend witnessed throughout 2022. Yet, beneath the surface the maturity in focus was not the same as what investors sought in 2022. Short-duration government bond funds had $954 million of outflows while intermediate- and long-duration bonds had a net $6 billion of inflows.
With the Fed continuing to hike rates, extending duration might be a bold strategy. Let’s see if it pays off.
EM bonds were the other notable category. They took in $2.8 billion in January, their second-most ever for a month and just $39 million behind the record total from January 2018. Back then, much like now, the dollar also fell (-3.3% versus -1.4% this January).2 Given EM debts’ strong correlation to currency effects, this is tailwind for the segment and a catalyst for the strong flows.
Fixed Income Flows
Being a forgetful goldfish can lead to overconfidence. For example, investors have ignored the weak earnings so far this year, as results have missed expectations by -0.8%, versus a +4.1% beat on average over the past four quarters.3 And only 62% of firms have surprised to the upside this quarter, compared to 70% on average over the past four quarters.4 These trends hold for earnings and revenues.5
Goldfish investors also are overlooking the ongoing weak guidance from firms around the world. Not to mention how the recent rally has pushed valuations back above historical averages.
Areas benefiting in this “goldfishian” rally have been heavily shorted, highly levered, poor quality, high beta, and past losers. Putting stocks with those attributes against a few red flags that only a goldfish would ignore raises questions on whether January’s strength can persist.
Shifting the equilibrium to include an elephant frame of mind means not swimming after what worked well in January. Rather, seek to balance offense and defense within equities and manage duration on the hunt for income in bonds.
You can find the full report on January ETF Flows here.
1 Bloomberg Finance, L.P. as of January 31, 2023 based on the performance of the S&P 500 Index and the MSCI World ex-US Index.
2 Bloomberg Finance, L.P as of January 31, 2023 based on the US Dollar Spot Rate.
3 FactSet as of January 31, 2023.
4 FactSet as of January 31, 2023.
5 FactSet as of January 31, 2023.
Bloomberg Commodity Index (BCOM)
Calculated on an excess return basis and reflects commodity futures price movements.
Bloomberg US Aggregate Index
Flagship measure of US investment grade debt from a multitude local currency markets. This benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds.
MSCI ACWI Index
Market-capitalization-weighted stock market index that measures the stock performance of the companies in developed and emerging markets.
MSCI World Ex-US Index
Market-capitalization-weighted stock market index that measures the stock performance of the companies in developed markets – excludng the US.
S&P 500® Index
Market-capitalization-weighted stock market index that measures the stock performance of the 500 largest publicly traded companies in the United States.
Term for rules-based investment strategies that don’t use conventional market-cap weightings.
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