Running the two-mile indoor track event requires both physical strength and a great deal of mental toughness. Not because of the distance, but because of the number of repetitive laps required — specifically at the home track I ran in high school.
To complete the two-mile, it took roughly 32 laps in a crowded, dusty gym that had the basketball bleachers running alongside it — and those were so close that if you leaned too much into your turn you might hit them.
Simply put, it was a long-distance track event that featured many laps where nothing changed. Doing something 32 times in a row can be disorienting, especially when trying to get in under 12 minutes. It required balance and discipline, as well as knowing when to change your approach — something that also required knowing what lap you were on.
A long timeframe that features constantly repeating intervals feels a lot like the current market sentiment and positioning. Ever since the vaccine timeline was established in November 2020, jumpstarting a recovery and reopening, positioning has been steadfastly cyclical.
Each month, it has largely been the same trend: value, cyclical sectors, credit, TIPS, commodities, and risk assets overall continue to perform well and garner inflows. Value over growth, small over large, high over low beta, and credit over rates have been good trades since then.1
This activity has been somewhat boring. Each month brings one more lap around the track, the same as the last. Yet, while each month (lap) has been similar, they are different. Much like lap 25 compared to lap five in the two-mile, it all looks the same but some circumstances (e.g., legs a bit more tired) have changed.
One of the most recent changes has been that interest rates have now fallen for two consecutive months. That change, however, is on the margins to a degree.
While rates have fallen, it has not been by much. They have largely remained range-bound since mid-April, with a bias upwards given consensus economic forecasts are for rates to be around 1.8% by year end with the reopening taking shape.2 As a result, the longer-term trend (track) of improving fundamental growth, rebounding economic data, and still-accommodative policies facilitating liquidity and risk-taking remains intact.
The boredom of a constant overarching cyclical trade, however, may lead some to start changing allocations. And like altering your breathing to adjust to the dusty gym air after lap 15, some changes are warranted — like a focus on Europe as result of their improving vaccination rates, fundamental sentiment, and economic growth data. But overall, the flow data suggests it’s still a ‘head down and run with cyclicals’ mentality, even with the recent move in rates.
Risk Assets Running Hard
With broad markets continuing to rally, investors once again turned to ETFs to deploy capital across a variety of strategies. ETFs had $65 billion of flows last month, the seventh consecutive month of more than $50 billion of inflows: a record streak.
During these past seven months, ETFs have now had over $540 billion of inflows — a record figure if it were a calendar year. Given this strength, 2021 calendar-year flow figures stand at $390 billion — the third-highest ever for a year, if the year ended today. But the year is not over and the markets continue to rally. If flows were to merely register the prior three-year monthly averages, 2021 flows could surpass $600 billion for the first time (+$665 billion). The same holds true if a five-year monthly average metric is used.
Like prior months (or laps), the higher-than-normal flows were led by risk-on equity ETFs and continue to paint a cyclically oriented bullish positioning picture. Equity ETFs took in $43 billion in May, their twelfth consecutive month with inflows — the longest streak of inflows since 2016 to 2018, when equity ETFs notched 20 straight months of inflows. Today’s strong flows and equally buoyant equity markets have propelled equity ETF assets to over $5 trillion for the first time ever.
From a geographical perspective, the US outpaced non-US-focused strategies (+$26 billion to +$16 billion). However, non-US exposures enjoyed stronger relative flows, given the smaller overall asset base ($1.2 trillion to $3.7 trillion), taking in 1.4% of their start-of-month assets compared to 0.7% for US-related ETFs.
Figure 1: Equity Geography (in $Million)
Regional funds posted records, led by Europe-focused ETFs. European equities have outperformed US stocks over the past three months and investors have started to take notice, evidenced by the $4 billion of inflows in May. In fact, there have been inflows of over $5 billion into European-focused ETFs since February — a figure that is approaching the 90th percentile, as shown below.
The recent rebound stems from improving earnings sentiment as well as positive vaccination progress and reductions in mobility restrictions. Altogether, this has started to improve the overall fundamental and economic outlook.
Figure 2: Rolling Three-Month Europe Flows
Cyclicals Ahead of the Pack
Sector funds posted inflows once again last month, their eighth in a row. Investors are seeking more than just plain beta to participate in a rally that has featured clear breakaway winners, given that sector dispersion is in the 99th percentile.3 The strong flows have pushed 2021 totals to a yearly record of $55 billion, and sector assets are now just $7 billion shy of $700 billion.
The sector flows were once again heavily skewed towards cyclical segments, such as Financials (+$4 billion), Energy (+$3.3 billion), and Materials (+$2.6 billion). Overall, cyclicals outpaced defensives by $10 billion in May — their tenth month in a row of doing so and now have outearned defensives by $86 billion over those months. And on a rolling three-month basis, the cyclical versus defensive difference is still well above the 90th percentile mark. In fact, this differential has now been above the long-term median for 11 straight months, and over the 90th percentile for the last seven.
Figure 3: Sector Flows (in $Million)
Style flows completed their latest cyclical lap. Value funds posted their second-highest monthly flows total ever at $10.8 billion, taking in more than growth funds for the tenth straight month — mirroring the cyclical flow pattern from sectors. Over these ten months, value funds have outpaced growth by a staggering $61 billion.
Over the past three months, $32 billion has been deposited into value funds, compared to $3 billion of outflows for growth. This has pushed the differential between value and growth funds to over $35 billion — a record well beyond the 90th percentile historically, as shown below.
Looking ahead, as reopening accelerates, cyclical exposures are likely to sustain this recovery momentum as a result of improving fundamental growth, rebounding economic data, and still-accommodative policies facilitating liquidity and risk taking.
Figure 4: Rolling Three-Month Style Flows
Reflationary Themes Persist in Bonds
Bond funds had more than $10 billion of inflows in May, their 21st month out of the past 22 and their 14th month in a row. And once again, we saw positive trends for credit-sensitive segments given that investors continue to search for income. High yield, senior loans and preferreds all had inflows last month, alongside another high-income segment, emerging market debt.
Within credit, loans have been highly sought after. Through the first five months they have nearly $6 billion, raising their start-of-year assets by a staggering 69%. Loans have had eight consecutive months of inflows, their longest stretch since 2017 when the Federal Reserve was raising rates.
Figure 5: Bond Flows (in $Million)
Beyond the search for income, bond investors have continued to steadfastly position for a reflationary regime shift as evidenced by the record-setting $3.1 billion of inflows into TIPS ETFs in May — their thirteenth consecutive month of more than $1 billion of inflows.
These strong flows have mirrored the trend in breakeven rates, as shown below, and pushed year-to-date totals to $14 billion, the second-highest for any bond sector we track. In fact, TIPS ETF assets are now just $4 billion shy of $80 billion.
Figure 6: TIPS Flows versus US 10-Year Breakeven Rates
Just Keep Running
Looking ahead, the macro backdrop continues to support an environment of focusing on rate-sensitive cyclical stocks and growth-sensitive credit-related bonds. Therefore, as we navigate the latest lap in this market rally track, having a cyclical/reflationary focus may continue to be rewarded, even if it is starting to become repetitive and a bit boring. Trying not to lose focus on what has got us here in the June lap will be important, especially with the summer months on the horizon.
1 Based on the returns of the S&P 500 Pure Value versus S&P 500 Pure Growth Index, the S&P 600 Small Cap Index versus the S&P 500 Index, the S&P 500 High Beta Index and the S&P 500 Low Volatility Index, and the Bloomberg Barclays US Corporate High Yield Index versus the Bloomberg Barclays US Aggregate Bond Index as of May 31, 2021.
2 Bloomberg Finance L.P., as of May 13, 2021, based on consensus economists’ forecasts.
3 FactSet as of May 31, 2021, based on the S&P 500 GICS Sectors.
Bloomberg Barclays US Corporate High Yield Bond Index
The index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch and S&P is Ba1/BB+/BB+ or below.
Characterized by higher price levels relative to fundamentals, such as earnings.
MSCI ACWI Index
A market capitalization-weighted index designed to provide a broad measure of equity market performance throughout the world.
MSCI EAFE Index
A market capitalization-weighted index designed to provide a broad measure of equity market performance covering developed market countries in Europe, Australasia, Israel, and the Far East.
S&P 500® High Beta Index
Designed to reflect the performance of the 100 highest beta stocks as measured by the beta to the S&P 500.
S&P 500® Index
A market-capitalization-weighted stock market index that measures the stock performance of the 500 largest publicly traded companies in the United States.
S&P 500® Low Volatility Index
Designed to reflect the performance of the 100 least volatile stocks as measured by standard deviation of returns.
S&P 500® Pure Growth and Pure Value Index
A style-concentrated index designed to track the performance of stocks that exhibit the strongest value or growth characteristics by using a style-attractiveness-weighting scheme.
S&P 600® Small Cap Index
A market-capitalization-weighted stock market index that measures the stock performance of the 600 smallest publicly traded companies in the S&P 1500 Index.
Characterized by lower price levels relative to fundamentals, such as earnings.
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