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Equity ETFs May Be the New Black Hole

Equity ETFs May Be the New Black Hole
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Tuesday, 01 August 2017 09:13 AM Current | Bio | Archive

Many years ago, Dennison Clothes in Union, New Jersey ran radio ads on WABC in New York with the catchy tagline: “Money talks, nobody walks.” The purveyors of equity ETFs don’t need any sales pitch apparently.

June’s data from the Investment Company Institute show that the money continues to pour in their doors:

(1) Equity mutual funds and ETFs. During June, all equity funds attracted $42.5 billion, with $32.9 billion flowing into ETFs and the remaining $9.6 billion going into equity mutual funds (Fig. 4). Over the past 12 months through June, equity ETFs have attracted an astonishing $357.8 billion, which is a record for them, while equity mutual funds have seen $119.8 billion walk out the door (Fig. 5).

(2) Domestic vs global ETFs. The record inflows into equity ETFs over the past 12 months through June have been led by ETFs investing in domestic equities, with inflows of $236.2 billion (Fig. 6). However, in recent months there has also been a remarkable flood of money running into equity ETFs that invest globally, with the 12-month inflow soaring to a record $121.6 billion.

(3) Bond funds. So far there has been no “great rotation” out of bond funds into equity funds. Over the past 12 months through June, bond funds attracted $378.3 billion, led by mutual funds ($273.4 billion) and followed by a record inflow into bond ETFs ($104.8 billion) (Fig. 7).

(4) Massive monies. In other words, the stock market melt-up is being driven by melt-ups in earnings and in equity ETF fund inflows. There has been a mini-rotation out of equity mutual funds into equity ETFs. However, on balance, money is pouring into both equity and bond funds at a prodigious pace. Over the past 12 months through June, money market mutual funds had net outflows of $13.6 billion, savings deposits rose $499.7 billion, and all equity and bond mutual funds and ETFs attracted $616.3 billion—for a grand total of $1.1 trillion (Fig. 8).

Global Economy: Mutual Attraction. While we are counting all the spare change going hither and thither, one of the bottom lines of our analysis is that all equity funds flows are showing a strong preference for global ones, with a net inflow of $158.5 billion over the past 12 months, over domestic ones, with a net inflow of $79.6 billion (Fig. 9). That’s because despite their outperformance so far this year, foreign equities remain relatively cheap compared to US equities, especially as foreign economies have been surprising on the upside whereas US economic growth has remained lackluster and somewhat disappointing overall.

Joe and I have been in the Stay Home camp since early in the current bull market. However, we backed off late last year, seeing merit in the Go Global approach for the time being. Consider the following developments:

(1) Performance. On a ytd basis through Friday’s close, the US MSCI has actually beat most of the other major indexes in local currency terms: Emerging Markets (18.3%), US (10.6), EMU (7.4), Japan (5.2), and UK (3.2). It has mostly underperformed in dollar terms: Emerging Markets (23.2), EMU (19.5), Japan (11.1), US (10.6), and UK (9.6) (Fig. 10 and Fig. 11).

(2) Valuation. The US remains relatively expensive according to the latest forward P/E derby as of July 20: US (18.2), UK (14.6), EMU (14.4), Japan (14.3), and Emerging Markets (12.5) (Fig. 12).

(3) Earnings. The forward earnings of the US MSCI continues to rise into record-high territory (Fig. 13). Languishing from 2011 through 2015, the forward earnings of the All Country World Ex-US MSCI is showing signs of a solid cyclical recovery since early last year.

The Fed: Same Old Song. It must be lots of fun being Fed Vice Chair. You get to go to fun places; all you have to do is dust off your speech on “The Low Level of Global Real Interest Rates.” That’s the one Stanley Fischer delivered yesterday at the Conference to Celebrate Arminio Fraga’s 60 Years, Casa das Garcas, Rio de Janeiro, Brazil. Sounds like a blast! Arminio had been the president of the Central Bank of Brazil from 1999 to 2002. He must be pleased that he hasn’t had anything to do with Brazil’s economic and financial debacle of the past several years, which Sandra Ward recapped for us in the 7/13 Morning Briefing.

Fischer addresses two questions that have been on his mind for a while, and that he has discussed in many recent speeches: “Why are interest rates so low? And why has the decline in interest rates been so widespread?” I think the short answer might be: “Because you and the other major central banks have kept them this low.” However, Fischer has a longer answer:

(1) Fischer rightly observes that actual inflation has been remarkably low and subdued around the world. This has kept inflationary expectations low, along with “credible central back inflation targets.”

(2) He also observes the obvious: “[T]he coincidence of low inflation and low interest rates suggests that the natural [real] rate of interest is likely very low today.”

(3) Fed researchers have found that the real interest rate has dropped 150bps since the financial crisis of 2008, and may be only 50bps currently. This decline seems to have occurred in a number of foreign economies.

(4) The declines might be temporary if they were mostly caused by a preference for safe assets after the crisis along with central banks’ QE programs, which should “fade over time.”

(5) For the US, Fischer sees “three interrelated factors that are likely contributing to low interest rates: slower trend economic growth, an aging population and demographic developments, and relatively weak investment.” Slower economic growth has been attributable to disappointing growth in productivity and the secular slowdown in the growth rate of the labor force.

(6) Interestingly, Fischer believes that capital spending has been depressed by political and economic uncertainty, especially about health care reform, deregulation, tax reform, and trade. Of course, these uncertainties have been heightened by the Trump administration. However, these were not major uncertainties for the eight years under the Obama administration, which is when the slowdown occurred.

A more interesting idea proposed by Fischer for the weakness in capital spending is that the pace of technological innovation is disrupting the “viability of long-standing business models,” which could be weighing on investment decisions.

(7) Fischer seems to endorse the Greenspan/Bernanke thesis of a global savings glut. His spin is that slower US economic growth has reduced the demand for foreign funds, which are keeping interest rates even lower than when the housing bubble was inflating prior to the 2008 financial crisis.

(8) Fischer worries that low interest rates can have adverse consequences, including increasing the risks of liquidity traps and financial instability if the low rate environment “leads investors to reach for yield or hurts financial firms’ profitability.”

(9) Fischer concludes by asking, “What, if anything, can be done about low interest rates?” Not much, as far as monetary policy goes. It’s really up to fiscal and regulatory policies, according Fischer.

The conclusion is that Fischer and other Fed officials have concluded that interest rates are likely to stay low and that they can’t normalize rates in the ways they had in the past.

Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.

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EdwardYardeni
Many years ago, Dennison Clothes in Union, New Jersey ran radio ads on WABC in New York with the catchy tagline: “Money talks, nobody walks.” The purveyors of equity ETFs don’t need any sales pitch apparently.
equity, etfs, black, hole
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2017-13-01
Tuesday, 01 August 2017 09:13 AM
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