US markets have recovered to start the year, but investors are abandoning ETFs that follow them.
According to Refinitiv Lipper data through Wednesday, investors have removed a net $31 billion from U.S. equity mutual funds and exchange-traded funds in the last six weeks. This is the longest string of weekly net outflows since last summer and the most money removed in aggregate from domestic equity funds to begin a year since 2016.
During the same time period, investors put almost $12 billion into foreign equity funds, about $24 billion into taxable bond funds, and nearly $3 billion into municipal bond funds.
Flows to funds other than domestic equities reflect a level of anxiety among investors who aren’t betting on a 2023 resurgence in US markets, according to several experts. The outflows offer little comfort to investors who are concerned that the market mood is changing. The S&P 500 fell 1.1% last week, its first weekly dip of the year, bringing its 2023 gains to 6.5%.
“The sense of opportunity certainly lies elsewhere,” said Cameron Brandt, research director at fund-flow and allocation data provider EPFR, of US equity funds.
The withdrawal from US stock funds highlights the divide between investors cautious about the market’s year-to-date surge and those anxious to ride the wave higher. Some investors are placing their money into ultrasafe fixed-income assets and selecting funds with cheaper equities from other countries.
Others are betting big on speculative equities and amplifying their chances with hazardous option trading. Some are scrambling to buy specific stocks like Tesla Inc., driving the electric vehicle company’s stock up 60% this year.
The rebound in 2023 has been fueled in part by expectations that the Federal Reserve will cut interest rates later this year as inflation moderates, despite the fact that central bank officials have repeatedly stated that higher rates will be maintained for a longer period of time in order to alleviate price pressures. Some investors were forced to reassess their expectations for Fed policy after January’s stronger-than-expected jobs data.
This week, investors will be looking for the most recent statistics on consumer and producer inflation, as well as retail sales, to determine the extent to which the Fed’s monetary policy is cooling the economy. Coca-Cola Co., Paramount Global, and Applied Materials Inc. are among the companies expected to post quarterly results as investors continue to scrutinise earnings for clues about the future of corporate profitability.
Rising interest rates have prompted some investors to seek out bond funds, since fixed-income assets provide the greatest payouts in more than a decade with little risk. The Bloomberg U.S. Aggregate Bond Index yields 4.5%, outperforming the S&P 500’s dividend yield of 1.7%.
In addition, investors are shifting into foreign stock funds since shares of firms outside the United States have outperformed those in the United States in recent months, aided by a weaker currency, optimism about China’s reopening, and favourable valuations.
According to FactSet, the S&P 500 is trading at about 18 times forecast profits over the next 12 months. On a local-currency basis, this compares to a multiple of roughly 13 for the STOXX Europe 600 and a multiple of around 10 for the Hong Kong Hang Seng Index.
“It’s definitely a sign that markets are still cautious, certainly for a segment of the investing public,” said Mr. Brandt.
Meanwhile, according to a Bank of America study of client equity flows released Tuesday, the gap between single-stock purchasing and ETF selling so far in 2023 is the biggest on record dating back to 2008. Year to date, clients have made net purchases of more than $15 billion in single equities, while ETFs have suffered net withdrawals of more than $10 billion.
According to Jill Carey Hall, U.S. equity strategist at Bank of America, the preference for individual stocks implies a more favourable environment for active management.
Since the introduction of the first ETF three decades ago, passive investing, or merely tracking the market, has grown in popularity. However, stock selection made a comeback last year as the megacap technology firms highly weighted in the major U.S. indexes faltered in a higher interest rate environment.
“We haven’t had to think about index construction in a long time because it was always ‘buy growth’ and ‘buy U.S. stocks,’ and now we’ve totally flipped that,” said Todd Sohn, an ETF strategist at Strategas Securities. “Investors and traders are trying to pick more quality names rather than playing the market through the indices.”
This year, clients are inquiring more about actively managed ETFs and bond ETFs, according to Mr. Sohn.
Other investors and strategists see flows to individual stocks as a hint of speculative purchasing this year because single equities can be riskier than diversified portfolios. Many of the top-performing equities in 2023 have been shares of growth-oriented firms that won’t be profitable for many years.
“Some market players are increasing the degree of risk they are willing to take,” said Bleakley Financial Group’s chief investment officer, Peter Boockvar. He favours energy and overseas equities and believes interest rates will remain high this year.
A surge of activity in the options market to begin the year, notably around wagers on technology companies, epitomises some investors’ appetite for risk.
Individual investors’ net purchases of single equities have increased since the beginning of the year, but net purchases of ETFs have remained flat, according to Vanda Research data.
Individual stock purchases have been dominated by one market darling: Tesla. According to Vanda, Tesla has accounted for almost a third of all single-stock net acquisitions by individual investors over the last several weeks.
David Jacobson, a 39-year-old high-school teacher from the Chicago suburbs, said he purchased Tesla stock for the first time in December and has progressively expanded his holdings over the past several months. Previously, he had only invested in funds linked to indexes such as the S&P 500 and the Nasdaq Composite, he explained.
Mr. Jacobson went on to say that he elected to acquire Tesla shares rather than rely on index funds to gain exposure to the firm because the cheap share prices were too attractive to pass up.
“I see a dip as a buying opportunity for a high-quality stock,” he said. “You just have to have faith that it’ll come back. Elon Musk is the Steve Jobs of our time.”