Stocks may have had a rough ride this week, but investors kept moving capital towards funds that invest in equities—a sign that optimism is holding strong on an already richly-valued market.
The S&P 500 fell 3.4% between Monday’s close and Thursday’s close. Although the index rose Friday, it still ended the week a tick down from Monday’s close. A spike in interest rates drove most of the move lower, with the 10-year Treasury yield hitting as high as 1.6% after beginning the week at around 1.4%—a sharp gain for just a few days. Higher yields on safe bonds make buying the riskier stocks less attractive.
Still, money flowed in the direction of the equity market: Investors poured $22 billion into stock funds this past week, according to data from Bank of America. That doesn’t necessarily mean the money went into shares of companies. Fund managers have discretion over when to deploy new capital. Currently, funds surveyed by BofA are holding just 3.8% of their portfolios in cash. This, BofA notes, signals that money managers are fully invested in the market.
The data showed that roughly $6 billion moved into U.S. exchange-traded and mutual funds, with the rest moving into emerging markets in other geographies. But capital wasn’t flowing into growth stocks, which saw a $2.5 billion outflow. Growth stocks large and small were badly hit this week, as higher interest rates have put an outsized dent on growth valuations.
However, the overall tone of the fund flow data is positive. “Part of the move into equities reflects optimism over the economy as we get into the second half of this year,” Michael Sheldon, chief investment officer of RDM Financial Group, told Barron’s. “Stock prices should tend to benefit from inflows into equity ETFs and mutual funds over time.” Indeed, BofA’s strategists wrote in a note that their statistical reading on investors’ collective sentiment is nearing an “extreme bullish” level—eliciting a sell signal.
The sentiment is consistent with stock valuations, which are getting a bit stretched. The equity risk premium on the S&P 500—the excess rate of return investors demand from stocks over and above the yield on the safe 10-year Treasury bond—is down to around 3.1%. The lower the premium expected return, the less attractive stocks are. (In the past decade or so, that risk premium often hovers around 3.5%, according to data from Morgan Stanley strategists.)
Stocks may have been working off some froth recently, but investors are willing to pay up to own them—for now.
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