Who sold at the lows for stock prices last week? And where did they go?
We look at one-week and month-to-date money flows for U.S.-listed exchange traded funds/products in an attempt to answer that question. The trail of bread crumbs is growing a bit faint, but here is what we know for sure: Over the past week, investors redeemed $13.7 billion in equity ETFs, with $10.6 billion of that from U.S. stock funds. Over the same week, investors added $5.9 billion to fixed-income funds and a further $589 million in assets to volatility/hedging ETF products.
Month-to-date in October, the equities-to-bonds swap is even more obvious: $16.4 billion out of stocks, $14.9 billion into bonds and $725 million into volatility/hedging products. Our bottom line: Overlevered hedge funds probably contributed to the sell off and V-shaped bottom. But so did a lot of plain-vanilla investment advisers and retail accounts.
(Related: Equity ETFs declined for 1st quarter in nine)
More volatility ahead is our call, with the potential for even lower yields.
Who made the bottom for stocks last week? Yes, we know that success has many parents and failure is an orphan, but someone is responsible for those two lows in the S&P 500 last Wednesday and Thursday at the 1820-1825 level on the futures. It may well have been different investors on both days, but the pattern of each day's trading is quite similar: sharp moves lower and then a quick shot higher. It's almost as if our mystery traders had been told to sell their positions immediately rather than liquidate them over the course of a day or two.
Whenever we see a bout of global capital markets volatility, we always head to the same place for some answers: U.S.-listed exchange traded funds. Not only are the assets under management substantial, at $1,845 billion, but with over 1,600 products on offer you can readily see where investor attention is shifting. ETFs are the “mood ring” of capital markets, for those of you old enough to remember those bits of costume jewelry-meets-heat-sensing plastic.
The other feature of the ETF landscape that makes them useful: Everyone from retail investors to registered investment advisers to the most sophisticated hedge funds use these products. That makes their creation/redemption process — when shares are added/taken from the fund in response to supply and demand — a true crossroads of capital markets sentiment.
We have very complete data from ETF flows through Oct. 20, courtesy of our friends at
www.xtf.com. They show:
Investors wanted out of equities last week — badly. In aggregate, they redeemed $13.7 billion of ETF shares in stock funds of all stripes, and $11.0 billion in U.S. stock funds specifically. The latter is the largest segment of U.S.-listed ETFs, with $947 billion in assets under management. Moreover, U.S. stocks are normally a magnet for incremental assets — the S&P 500 SPDR Fund is the largest listed ETF in the U.S. — so when you see outflows, you know investors are notably risk averse.
They didn't flee to cash however. They bought $5.9 billion in fixed-income ETFs instead. Yes, several of the top 20 fixed-income asset-gatherers last week were shorter-duration-bonds funds, but more were total bond market funds and high-yield corporate bond products. This was money looking for a lasting home — not just a safe cash “parking lot” until the equity markets calmed down.
Another interesting point about last week: The demand for volatility/hedging products rose considerably. These are the funds with all the warning screens when retail investors try to buy them — the ones that reset daily so that you have to catch the pop in volatility just right in order to profit from the move. Those funds drew an incremental $589 million on a total asset base of $4 billion — more than 10% growth in just seven days.
Looking at the flow data for the whole month of October shows an almost perfect swap from stocks into bonds. The precise numbers: $16.4 billion out of equity products (of which $4.5 billion were U.S. stock ETFs) and $14.9 billion into fixed-income funds. Where did the remaining $1.5 billion go? Almost half — $725 million — flowed into those volatility-oriented products we mentioned.
Based on this data, it seems like we have a “Murder on the Orient Express” kind of solution to the question of who killed the global equity market rally. Sorry if you haven't read the book or seen the movie, but here is the answer: All the suspects had a hand in the murder. Here's how it likely played out:
Hedge funds use ETFs to, well, hedge. When they get a margin call, they use less of these products as they reduce the total size of their portfolios. Less demand equates to a reduction in shares outstanding for the ETFs in question, typically equity products used to hedge single stock investments.
Hedge funds also use the volatility products as hedges during periods of market volatility. The advantage to that approach versus a simple short position is that these ETFs can provide a lot more “bang” for the hedging “buck.”
Registered investment advisers are increasingly using ETFs for low-cost asset allocation strategies on behalf of their clients. As stock markets began to get twitchy in October, it would have been this ETF user group that would have reweighted portfolios to bond ETFs and away from stocks. This explains the very broad base of bond ETF purchases in October, rather than just short-term cash equivalents that hedge funds might use.
Retail investors are also active users of stock and bond ETFs, but they also use the volatility products as day-trading tools. They would act like a hybrid of the hedge fund and the RIA communities, both reallocation of capital from equities to fixed income and having a go at playing volatility ETFs as well.
The upshot — at least from this cut at the data — is that several investor types had a hand in setting those lows last week. It wasn't just hedge funds — they have no need for the long-dated bond funds that certainly benefited from last week's sell-off. And it wasn't just RIAs — they don't typically trade volatility products (too spicy for their taste). And retail — it would take a lot of individuals all acting in concert at exactly the same moment to get the kind of moves we saw last week.
So what do we make of this analysis as far as where markets go from here? Two final points:
Equity markets will remain volatile for a while longer — almost certainly until the end of the year. With the Federal Reserve ending its bond-buying program this month, investors will keep a weather eye on incremental signs of domestic or global economic weakness. Any signs of slowing and we will see the same trade as last week all over again: out of stocks, into bonds and (a little) into volatility plays. This wasn't a one-act show we got to watch last week. It was several acts, with intermissions of various lengths.
As a result, the rate cycle isn't over yet and global bond yields can easily grind even lower from here. The reason is simple: investors have made large profits in their stock portfolios and they will shift them to bond products to lock in those gains. Declining oil and other commodity prices are signaling the all-clear for investors to own more fixed income here, not less.
In summary, the October ETF money flows are a case study in how capital may well move for the rest of the quarter and into 2015. It isn't the consensus “Stocks up, bonds down, Great Rotation call,” but the money flows show a different picture.
Nicholas Colas is chief market strategist at ConvergEx Group, a global brokerage company based in New York.
