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Outflows From U.S. Stocks Swell as Investors Seek Refuge in Bonds

26 Jul 2018 9:30 am
By Michael Wursthorn and Daniel Kruger 

Investors are fleeing U.S. stocks at a rapid clip as the possibility of a protracted trade dispute between the world's two largest economies pushes them to seek safety among less risky assets such as U.S. Treasurys.

More than $20 billion was pulled from long-term mutual funds and exchange-traded funds focused on U.S. stocks in June, capping the third-worst first half for equity flows over the past 10 years, according to data provider Morningstar LLC. The trend doesn't appear to be slowing: Investors redeemed more than $11.6 billion from domestic stock funds in the three weeks ended July 18, according to the Investment Company Institute.

The exodus coincides with the implementation of the first round of tariffs between the U.S. and China, as well as President Donald Trump's consideration of additional levies on more than $200 billion of goods. But it also comes against a backdrop of robust corporate earnings and strong U.S. economic growth that has pushed the S&P 500 up 6.5% this year.

Analysts have long been critical of the predictive power of fund flows in calling a broad market shift. The data reflect how money is moving across investment products but aren't necessarily a good gauge of investor sentiment. Plus, individual investors are often bad at timing the market, buying high and selling low.

Still, after a more than nine-year rally in U.S. stocks, several investors say this year's ongoing volatility and trade tensions are forcing them to pause to reconsider whether a stock-heavy portfolio can sustain a tit-for-tat trade conflict, not just with China but other major trading partners. Other investors appear to be waiting on the sidelines, with stock-trading volumes dropping to their lowest levels of the year in recent weeks.

PNC Financial Services Group Inc., for one, has been urging clients with heavy exposure to stocks to pare those positions and buy more government bonds. Resurgent volatility has forced investors to confront a period when "stock prices not only go up, they can go down," said Jeff Mills, co-chief investment strategist for PNC, which manages $149 billion in assets. "We're making sure investors have their house in order."

Russell Investments, meanwhile, reiterated its "underweight" preference for U.S. stocks last month, which suggests investors reduce equity allocations, and shifted its view of U.S. government bonds to neutral from underweight.

Those sentiments helped drive more than $80 billion of inflows into taxable bond funds in the first half of the year, outpacing the roughly $60 billion that was pulled from U.S. stocks over the same period, according to Morningstar's data. At the same time, asset managers including investment giant BlackRock Inc. have recently reported a s ubstantial slowdown in inflows. Money coming into passive funds that track the market dropped 44% through the first half of 2018, Morningstar said.

Short-term bond yields have become more attractive in the meantime. As the Federal Reserve has continued its campaign to raise interest rates, the yield on the two-year U.S. Treasury note recently rose to 2.655%, versus the S&P 500's dividend yield of 1.9% -- the widest disparity since the 2008 financial crisis, according to State Street Global Advisors.

"Risk-adjusted returns on stocks versus Treasurys are not as compelling as they have been," said Brian Nick, chief investment strategist at Nuveen.

Outflows from stock-focused funds likely would have been more severe if the U.S. market weren't on better footing than major indexes in Europe and Asia, analysts said. Stocks overseas have seen more volatility in recent months amid the tariffs talks and signs of slowing economic growth.

"The U.S. economy is experiencing robust earnings," said Erik Knutzen, multiasset-class chief investment officer at Neuberger Berman, which has been increasing its exposure to large-cap stocks, a major contributor to the S&P 500's gains this year. "There's a strong short-term impulse in the U.S., and we want to make sure we have exposure to that." Mr. Knutzen added investors should remain cautious and consider reducing some of their biggest asset allocations to a more neutral stance as "we wait for more clarity on trade concerns" among other risks, such as a resurgent U.S. dollar and the midterm elections this fall.

Although analysts say companies are on their best financial footing in years, more investors fear stocks are going to languish in the second half of the year. The share of individual investors who expect stocks to fall over the next six months was 39% earlier this month, near its high of the year, according to an American Association of Individual Investors survey. Measures of consumer confidence and optimism among small-business owners also fell in the past month.

Demand for bonds, meanwhile, is expected to pick up as the Fed unwinds some of its massive bond portfolio. That has the potential to dramatically reshape investors' portfolios after years of easy-money policies made bonds relatively unattractive. Currently, stockholdings for nonbank investors are near their highest in the post-2008 period, while those for bonds are at new lows, according to JPMorgan Chase & Co.

The supply of debt is also rising. The U.S. government sold $1.1 trillion of notes and bonds in the first six months of the year, a 9.2% increase from the year before. That amount is expected to continue climbing as the Treasury raises cash to help fund the $1.5 trillion tax cut passed in December.

"You now have a risk-free asset that generates something of a real return--that explains a lot of the shift" to bonds from stocks, said Simona Mocuta, an economist with State Street Global Advisors. Investors no longer have to forgo investment income in order to preserve capital, she said. "The risk-reward calculation has changed."

Write to Michael Wursthorn at Michael.Wursthorn@wsj.com and Daniel Kruger at Daniel.Kruger@wsj.com

(END) Dow Jones Newswires

July 26, 2018 05:30 ET (09:30 GMT)

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