Going with the (in)flow in January

Mike Loewengart, Vice President of Investment Strategy

E*TRADE Capital Management

02/01/18

Coughs, sniffles, and sneezes seemingly know no bounds this winter. The Centers for Disease Control and Prevention says we’re in the midst of one of the more prolific flu seasons in recent memory.1 For global equities markets, a condition of an entirely different order seemed pervasive in January—FOMO, or the fear of missing out.  

Some market observers noted that flow data seemed to confirm that growing fear of not capitalizing on the still upward-trending equities markets. What supported that diagnosis? According to financial intelligence firm EPFR Global, inflows into the equity funds it tracks ran five times greater than during the same period in 2017.2

A number of factors had investor optimism ramped up in January. Beyond the US’ new lower corporate tax rate and repatriation incentives, economic growth remained strong. The advance estimate of fourth-quarter 2017 gross domestic product (GDP) at 2.6% fell short of expectations, but it was solid enough after 3.1% in Q2 and 3.3% in Q3. Bouts of dollar weakness throughout the month may have been a catalyst as well, especially for multinationals.

Fixed income didn’t get a clean bill of health, though. Investors seeking riskier assets as well as concerns about inflation and higher interest rates likely spurred bond selling. Yields trended higher, sparking the type of volatility bondholders hadn’t seen in years.

Real gross domestic product, 02/01/18

Source: Bureau of Economic Analysis

Domestic equities

Little stood in the way of US stocks in January—the NASDAQ (+7.27%), the S&P 500® (+5.67%), and the Dow Jones (+5.49%) were all up, despite a spat of late month volatility. Most wrote off the government shutdown as a non-issue; in fact, the benchmark S&P closed at an all-time high on January 19 as the deadline approached. In all, it closed at a record high 13 times, the most for any calendar month since February 1998.3

One indicator of Wall Street bullishness is its deal-making tally. In January, the value of announced mergers and acquisitions was the highest since 2000.4 Perhaps helped by several high-profile deal announcements, health care (+6.65%) had an active month. And that was despite a sell-off following news of Amazon, JPMorgan Chase, and Berkshire Hathaway partnering on a joint health care unit.

Overall, consumers powered the discretionary category (+9.34%) to lead all sectors after spending grew a strong 3.8% in Q4, the biggest increase in almost two years. Tech (+7.63%) followed with a number of firms set to repatriate cash held overseas. Not surprisingly, investors left the income-oriented and interest rate-sensitive utilities (-3.07%) and real estate investment trust (-1.89%) sectors behind.

US equity performances in January, 02/01/2018

Source: FactSet

International equities

Investors continued to recognize that there’s a big world out there, and that half of the global equity market cap resides beyond the US. Performance-chasing, amid what appear to be stretched valuations at home, along with growth synchronizing across markets had investors turning their gaze abroad.

A recent E*TRADE survey illustrated that point. In January, 67% of investors surveyed who have more than $1 million in brokerage accounts said foreign markets looked attractive to them and that they are much more likely to invest overseas in 2018, up from 51% in Q4.5

That type of risk-on mentality had the MSCI ACWII Index (+6.3%), which tracks developed and emerging equities, well into positive territory. But emerging markets remained the story. The MSCI EM Index (+9.89%) picked up where it left off in 2017—outperforming developed markets, including the US. The MSCI Latin America Index (+13.08%), which captures large- and mid-cap representation across EM countries Brazil, Chile, Colombia, Mexico, and Peru, led the way among regions, likely boosted by rising commodity prices.6

International equity performances, 02/01/2018

Source: MSCI

Fixed income

Several factors conspired to weigh on the bond market. Market observers highlighted a few big ticket items, such as the accelerating economy and investors taking on more risk. Also, investors may have considered the risk of higher inflation potentially causing the Federal Reserve to raise rates more than the three 0.25% increases it has signaled for 2018.

In response, Treasury yields, which move opposite of price, increased significantly. The yield on the 10-year Treasury note touched a three-year high of 2.75% before ending the month at 2.72%. The 10-year affects a range of business and consumer loans, including home mortgages. The two-year yield rose to 2.14%, its highest since 2008. A byproduct of higher bond yields and US dollar weakness likely sent gold soaring. Investors turning to the precious metal, a traditional hedge against inflation, pushed prices to their highest level since August 2016.  

By segment, Treasuries with maturities 10 years and longer (-2.87%) were the worst performing area of the bond market. High yield corporates were one of the few winners at (+0.60%), as spreads contracted to near pre-financial crisis levels. Short-term Treasuries of one to three years were next in line (-0.31%), though well behind. 

US benchmark Treasury bond yields, 02/01/2018

Source: US Department of the Treasury

The bottom line

Eventually the market is going to catch a bug and revert. But when that day comes, it doesn’t have to be anxiety-inducing. Pullbacks can be healthy and create opportunities within the context of a diversified portfolio focused on long-term goals.

After a month that brought more records, yet growing intrigue, about just how high the market can go, consider the following:

  • Be mindful of risk levels. Each move higher in the equity markets can mean more risk than intended in a portfolio. Take the time to rebalance back to target goals in order to align with desired risk levels. 
  • Broaden horizons. Letting go of home country bias could offer exposure to valuations that are generally more attractive than those in the US.
  • Bonds deserve their due. Bonds can still provide portfolio ballast and income can be reinvested at higher rates, helping to boost total returns.

In our view, keeping a diversified portfolio of both stocks and bonds is the best approach to not only gain exposure to performing assets, but also to ease risk when the market starts to turn its head and cough. 

As always, thank you for reading. 

 

Mike Loewengart

Vice President, Investment Strategy

E*TRADE Capital Management, LLC

 

Additional contributor:

Andrew Cohen, CFA

Director, Investment Strategy

E*TRADE Capital Management, LLC

 

Mike Loewengart is the Vice President of Investment Strategy for E*TRADE Capital Management, LLC. Mike is responsible for the asset allocation and investment vehicle selections used in E*TRADE’s advisory platforms. Prior to joining E*TRADE in 2007, Mike was the Director of Investment Management for a large multinational asset management company, where he oversaw corporate pension plan assets. Early in his career, Mike was a research analyst focusing on investment manager due diligence for the consulting divisions of several high-profile investment firms. Mike holds series 7, 24, and 66 designations, as well as the Chartered Alternative Investment Analyst (CAIA) and Certified Investment Management Analyst (CIMA) designations. He is a graduate of Middlebury College with a degree in economics.

Andrew Cohen is a Director of Investment Strategy for E*TRADE Capital Management, LLC. Prior to joining E*TRADE, Andrew was the Director of Investments and Operations for a large Registered Investment Advisor, where his responsibilities included investment manager research, asset allocation, and portfolio construction. Previously, he was a Senior Research Analyst and Team Leader for a leading wealth management platform. He is a CFA charterholder and a member of both the New York Society of Security Analysts and CFA Institute. He is a graduate of Virginia Tech with a B.S. in Finance.

 


1. “Situation Update: Summary of Weekly FluView Report,” Centers for Disease Control and Prevention, 26 Jan. 2018. https://www.cdc.gov/flu/weekly/summary.htm

2. Mullen, Cormac. “Biggest Stock Sell Signal Since 2013 Sparked by Record Inflows,” Bloomberg, 26 Jan. 2018. https://www.bloomberg.com/news/articles/2018-01-26/biggest-sell-signal-for-stocks-since-2013-hit-with-record-inflow

3. Van Doorn, Philip. “These 27 S&P 500 stocks are blowing away the market with gains of 15% or more this month,” MarketWatch, 28 Jan. 2018. https://www.marketwatch.com/story/these-27-sp-500-stocks-are-blowing-away-the-market-with-gains-of-15-or-more-this-month-2018-01-26

4. Ahmed, Nabila and Baigorri, Manuel. “Dealmakers Are Off to Hottest Start of the Year Since 2000,” Bloomberg, 23 Jan. 2018. https://www.bloomberg.com/news/articles/2018-01-23/dealmakers-are-off-to-the-hottest-start-of-the-year-since-2000

5. Rosenbaum, Eric. “Where investors who manage their own millions see best 2018 stock values,” CNBC, 26 Jan. 2018. https://www.cnbc.com/2018/01/26/where-investors-who-manage-their-own-millions-see-market-value-in-2018.html

6. According to Morningstar as of February 1, 2018. http://news.morningstar.com/index/indexReturn.html