To The Moon

Wall Street stocks may now technically be in a bull market, but exchange traded fund investors appear to be largely resisting the siren call to jump on board the rally.

Net inflows to US equity ETFs did tick up to $22.1bn in May, their highest level this year, according to data from BlackRock. However — technology stocks aside — there seemed to be greater enthusiasm for more idiosyncratic assets such as Japanese equities and gold.

“The overarching theme is that flows did pick up in US equity, but still nowhere near the peak of flows we have seen in the past,” said Karim Chedid, head of investment strategy for BlackRock’s iShares arm in Europe, the Middle East and Africa.

The relatively lacklustre buying is suggestive of unusually muted enthusiasm for US stocks, even though the S&P 500 is up more than 20 per cent from its October low.

The breaching of the bull market barrier was greeted by analysts at Morgan Stanley with a warning that they “still expect a meaningful earnings recession this year [a 16 per cent year-on-year decline] that has yet to be priced in”. Meanwhile, Mark Haefele, chief investment officer of UBS Global Wealth Management, recommended “investors continue to exercise caution” as “it’s impossible to know whether the bear market trough — the ultimate low of the market cycle — is behind us”.

“If the economy were to contract later this year, as we still think it will, times might get a lot tougher for equities,” said Thomas Mathews, senior market economist at Capital Economics.

Scott Chronert, global head of ETF research at Citigroup, said inflows into technology-focused ETFs “tell an AI story”, as investors bet that rapid developments in artificial intelligence will benefit the bottom lines of a handful of tech stocks, while outflows from economically sensitive sector ETFs point to “ongoing recession concerns”.

Chedid noted that a notional “S&P 492” — the flagship index robbed of its eight largest constituents — is actually down a fraction this year. Against this backdrop, ETF investors “have been buying the concentrated part of the market through tech exposures”.

Tech ETFs globally took in a net $15.9bn in May, BlackRock’s figures show. Chedid cautioned that this figure had been artificially inflated by $5.5bn due to technicalities related to the reclassification of some tech stocks as financial companies.

Aerial view of Mount Fuji

Column chart of Weekly flows into tech ETFs, January-May 2023 ($bn) showing Tech tonic

Nevertheless, even $10.4bn, driven by six straight weeks of inflows, is still enough to make tech comfortably the most popular sector year to date. “

There is a sentiment story about tech. It makes sense why it happened because we have had the AI rally,” said Chedid, adding that although positioning in the futures market in broad US equities “doesn’t look crowded, it does in the [tech heavy] Nasdaq”.

Some of those unenthused about the US stock market are instead looking at Japanese equities. US and European ETFs focused on Tokyo stocks attracted a net $1.9bn in May, the second $1bn+ month in a row and the strongest buying since 2020.

Column chart of Monthly net flows into European and US-listed Japanese equity ETFs ($bn) showing Japanese equities in favour

“Funds providing exposure to Japanese equities have been popular as US investors sought out the high dividend yields offered in the developed international markets,” said Todd Rosenbluth, head of research at VettaFi, a consultancy.

His data showed that the iShares MSCI Japan ETF (EWJ) pulled in a net $715mn in May, while the currency hedged WisdomTree Japan Hedged Equity ETF (DXJ) attracted $240mn. “

Overseas buying is picking up from nowhere,” said Chedid, something he attributed in part to an “acceleration” in Japan’s corporate reform agenda that has ushered in “significant improvements in shareholder responsible behaviour”.

In addition, he also cited an “interesting” macroeconomic environment in Japan, with growth firming even as it falters elsewhere due to the country’s late emergence from Covid lockdowns. “

They reopened much later which means they are still experiencing a reopening trend, so growth is still picking up”, Chedid said. “They are also seeing inflation pick up. [That combination] is usually good for markets and it’s out of cycle with the rest of the world.”

He forecast that foreign buying of Japan “has further to go”, given that ownership is still limited. “

Based on [BlackRock’s] analysis of expected performance for Japan, an optimised [global] equity portfolio would have a 10.2 per cent allocation to Japan, but this currently sits at 4.8 per cent,” Chedid said.

Line chart of Cumulative net flows into gold ETFs since January 2021 ($bn) showing Gold shows its mettle

Gold ETFs also shone, with May flows of $1.9bn taking the tally since March to $4.3bn, following a long period where they were out of favour, with net outflows of $27.2bn between April 2022 and the turning point in March.

Rosenbluth said gold ETFs were a “safe haven for investors during the US debt ceiling crisis”, with SPDR Gold Shares (GLD) adding $875mn and the cheaper SPDR Gold MiniShares Trust (GLDM) $205mn.

The resolution of that crisis might erase a source of support for the metal, but Chedid believed there were still “buyers out there” despite gold trading near all-time highs. “Real rates have stabilised and physical demand has returned, when it was pretty lacklustre for four years because of lockdowns in India and China, the two largest markets. And central banks are buying gold,” he said.

Overall, ETFs took in a net $77.3bn in May, up from $53.5bn in April, with equity flows coming in at $41.8bn, up from $26.9bn in April, and fixed income ticking up from $25.2bn to $33.1bn.

$iShares MSCI Japan ETF(EWJ)$ $Gold - main 2308(GCmain)$ $Gold - Jun 2023(GC2306)$ $VanEck Gold Miners ETF(GDX)$ $Invesco QQQ Trust(QQQ)$ $HSTECH ETF(03032)$

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