Equity bulls aren’t as bullish as they seem
Risk-hungry investors turned into selective optimists last week. This statement may come as a surprise, considering the persistent rise in US equities. After all, SPDR’s S&P 500 ETF Trust (SPY) closed higher for a fourth consecutive week, locking in a weekly gain of ~0.7%. Plus, three of the four major US equity index ETFs (DIA)(IWM)(QQQ) also advanced.
Gains were largely driven by positive earnings surprises, especially in the technology sector. A prominent example was the ~5.3% weekly gain in Microsoft (MSFT). Note that shares of the company make up ~8.2% of the PowerShares QQQ Trust’s (QQQ) market cap–weighted portfolio, which helped the tech-focused ETF post the largest weekly gain among the big four US index ETFs.
Only looking at returns, we saw that market sentiment appeared strongly bullish. But don’t be fooled. Taking fund flows into account, we see that last week’s equity gains were largely driven by a rotation out of high-beta into low-beta stocks. The chart below provides the first hints of this rotation.
Better safe than sorry
Three out of four major US index ETFs saw outflows last week. In total, investors pulled out ~$2.1 billion, which contrasts the broad-based rally in US equities at first. As we mentioned above, however, it’s worth examining the nature of these flows. Consider that ~95% of total outflows were in the two riskiest index ETFs, judged by their beta to SPY. The PowerShares QQQ Trust (QQQ), which has a two-year raw beta to SPY of 1.2, registered ~$1 billion in outflows. iShares’ Russell 2000 ETF (IWM), with a beta to SPY of 1.1, saw almost the same amount leave the fund. On the contrary, the relatively stable SPDR Dow Jones Industrial Average ETF Trust (DIA) saw inflows of ~$300 million (a two-year raw beta to SPY of <1).
What does all this information tell us? Essentially, investors became more defensively positioned and more selective as US equities traded in uncharted territory. Fund flows illustrate that optimism generally prevailed but that the risk-to-reward profile of high-beta exposure is becoming too risky for many investors. Whether this trend continues over the next few weeks is worth monitoring to avoid losing much-needed basis points.
In Part 2 of this series, we’ll see whether a similar shift in assets was also visible on a GICS sector ETF level. Read on to learn more.