On Fruday, while confirming that the meme of “Fake News” has officially gone too far, Goldman Sachs slammed the talk of a Great Rotation from bonds into stocks (yes, calling it fake news), and writing that “the political rotation occurring in Washington, D.C. will not be mirrored in financial portfolios: despite the sharp fall in bond values during the past six months and the prospect of further losses in 2017, Goldman expects minimal asset rotation away from debt and into equities for two reasons. i) Many categories of investors are restricted from allocating assets away from bonds; ii) Investors such as pension funds and households that have latitude to shift assets have debt allocations that are currently at the lowest level in 30 years. Mutual funds may see a migration of assets from bonds to stocks, but the pace and magnitude of any rotation will be limited.”
For now, however, this particular piece of “fake news” appears all too real, at least as shown in a dramatic reversal in fund flows since the election.
Case in point: last week, TrimTabs Investment Research reported that U.S. equity exchange-traded funds issued a record $59.9 billion in December, easily surpassing the previous record of $50.7 billion in November.
“Investor appetite for U.S. equities is seemingly insatiable,” said David Santschi, chief executive officer of TrimTabs. “U.S. equity ETFs have had inflows on all but six trading days since the U.S. presidential election, and the buying volume has been by far the strongest we’ve ever seen.”
In its note, TrimTabs explained that the inflow of $110.6 billion into U.S. equity ETFs in November and December combined is equal to a stunning 7.2% of these funds’ assets.
TrimTabs also pointed out that last year’s fund flows reveal an overwhelming preference for passive U.S. equity products. U.S. equity mutual funds, most of which are actively managed, lost $233 billion in 2016, their third consecutive annual outflow. U.S. equity ETFs, almost all of which are passively managed, issued $169 billion, their seventh consecutive annual inflow.
This was confirmed by BofA data over the weekend, which noted that of the $5.5 billion in global equity inflows in the first week of the year, $9.3 billion was to ETFs, while active managed funds saw another $3.7 billion in outflows. Still, as the previously noted chart from EPFR showed, the amount of capital allocation of US equities is simply stunning.
So while the record inflows into US stocks continues, bets against Treasuries keep hitting new all time highs. According to Deutsche Bank, speculators maintained their last week’s trend and added another $15.1 billion – in ten-year cash equivalents – to their net shorts in Treasury futures to $91.7 billion, a new record high since at least 2009. FV and TY net spec shorts marked new record highs of 411K (+74K) contracts and 345K (+4K) contracts, respectively. Specs also sold 17K contracts in TU and over 11K contracts in the two bond futures, in each. In addition, they increased net shorts in Eurodollar futures by 210K contracts to -2,116K contracts.
The unprecedented short bias in the Treasury market is shown in the charts below:
At some point these record short bets across the Treasury complex will reverse, leading to a violent short squeeze-driven rally, although – as always – the question is “when”?
Which takes us back to the equity flows and a warning by CEO Santschi, who said that “fund flows tend to be a good shorter-term contrary indicator, so the post-election buying spree bodes poorly for U.S. equities” and added that “selling that had been postponed late last year in anticipation of lower tax rates this year could put downward pressure on the market.”
For now the only pressure the market is facing is whether Friday’s approach of Dow 20,000 to within less than a point may have signalled the top, or is just the start of the next move higher, which as even Goldman admits, would push the market even higher above the current level of 20.3x forward operating earnings.