“Dumb” money. Retail investors. Dip-Buying. And on, and on.
That’s been the meme in 2017 when it comes to explaining equity exuberance in the face of a tumbling dollar and a yield curve that’s not looking very reflation-ish lately.
Well, despite all the evidence we thought we had, and despite the clear disconnect between “soft” data (sentiment, “hope”, etc.) and “hard” data (“reality,” for short), Goldman is out on Tuesday with a rather surprising assessment: “Retail money is not driving this rally.”
Read Goldman’s take below to find out why we and everyone else (including Goldman itself) may have been wrong to blame “stupid” mom-and-pop for equity resilience.
Household and small business sentiment has surged since Donald Trump won the US election. The University of Michigan’s consumer sentiment index reached a 13-year high, and last week the Conference Board’s index of consumer confidence rose to its highest level in 16 years. The NFIB’s small business optimism index is at a 12-year high after having recorded its largest-ever two-month increase in November and December.
Markets have shared in this optimism. The S&P 500 is up 10% since the election, spreads on the BAML HY index have rallied more than 100bp to an OAS of 392bp, and the VIX recorded its lowest-ever quarterly average in Q1. Mutual fund flows have surged as well. In the week following the election, EPFR data show that flows into North American equity funds rose to approximately $30bn. Since then, equity funds have seen an additional $60bn of net inflows.
It is tempting to draw a connection among these facts by concluding that the sentiment of households is translating into the sentiment of retail investors and thus supporting equity markets via strong mutual fund inflows. Indeed, in the note cited above, we ourselves assumed such a link between consumer and investor sentiment. But this link does not stand up to scrutiny.
While it happens to be true that robust inflows to equity mutual funds have accompanied the surge in sentiment surveys, a more granular look at the evidence suggests this is more of a one-time aberration than a stable, long-standing correlation. EPFR categorises mutual funds as ‘Institutional’ or ‘Retail’ based on three criteria: (1) which type of investor the fund targets in its prospectus, (2) the minimum initial subscription amount to invest in the fund ($100K USD or higher = institutional), and (3) the share-class (‘I’ share for institutional vs ‘A’, ‘B’, ‘C’ shares for retail).
Exhibit 1 below plots the weekly mutual fund flows from EPFR (for institutional investors and retail investors, respectively) vs weekly data on the Bloomberg Consumer Comfort Index (BCCI). The BCCI is a weekly measure of investor views on the condition of the “US economy, personal finances and the buying climate”, and we prefer it here over the better-known Michigan and Conference Board surveys because it is conducted on a daily basis and made available weekly. The plots show 4-week differences of 4-week moving averages, while fund flows are shown as 4-week moving averages of the weekly flows as a percentage of assets under management (these transformations yielded higher correlations after experimenting with various alternatives.)
Splitting mutual fund flows into institutional vs retail reveals that since the election, the institutional component of these flows (Exhibit 1, left) has been more important than the retail component (Exhibit 1, right). This is perhaps not surprising since institutional investors account for roughly three-quarters of the ownership of the EPFR universe of equity mutual funds. But it is more than mere ownership shares, because while institutional inflows amounted to 0.86% of AUM in the week following the election, retail investors were actually sellers. While the market has clearly been rallying on ‘animal spirits’, it is apparently the professional investors, not the retail money, who have been feeling bulled up.