If you’re looking for reasons why U.S. equities have remained resilient in the face of myriad geopolitical land mines and incessant headline risk around the trade wars, you can point to two things: the corporate bid (i.e., buybacks) and earnings growth.
Both of those pillars are to a certain extent a function of the tax cuts and late-cycle fiscal stimulus in the U.S. Additionally, strength in U.S. small-caps is seemingly predicated on the notion that they’re less exposed to the trade war, although some desks have recently raised questions about the viability of that thesis, Barclays being perhaps the most notable.
While the buyback pillar isn’t likely to crumble anytime soon (and could in fact become stronger in the event there’s a pullback that incentivizes management to go “bargain” hunting in their own equity), earnings are at risk from the trade tensions.
Guidance cuts have been few and far between thus far (although Alcoa may have been a canary), but as Goldman wrote last week, margin pressure could begin to materialize as input costs rise. Here’s what the bank wrote in a note dated Friday:
We assume that S&P 500 companies, which are more global in nature and have more complex supply chains, import roughly 30% of COGS. This is consistent with the 29% of S&P 500 sales is generated outside the US. Imports from China comprise 18% of total US imports. Conservatively assuming no substitution to other suppliers or pass-through of costs, and no boost to domestic revenues or change in economic activity, a 10% tariff on all imports from China would lower our 2019 S&P 500 EPS estimate by 3% to $165. If tensions spread and a 10% tariff were implemented on all US imports (highest rate since 1940s) our EPS estimate would fall by 15% to $145.
When it comes to who will be the “marginal buyer” of equities outside of corporate management teams, there’s reason to believe the retail bid has gone missing. BlackRock’s quarterly results, for instance, showed investors pulled more than $22 billion from the firm’s equity products during Q2:
In the press materials, Larry Fink mentions an “industry-wide slowdown in flows associated with investor uncertainty in the current market environment.”
JPMorgan’s Nikolaos Panigirtzoglou has been keen on documenting that trend lately and in his latest piece, out Friday, he notes that “June was the first month since October 2016 just before the US election that retail investors turned net sellers of equity funds globally.”
Disaggregating the ETF data, Panigirtzoglou shows the clear preference for U.S. stocks amid the trade tensions. “All three main non-US equity regions have been experiencing outflows over the past three months — EM, Europe and Japan — at the same time as the US saw inflows”, he writes, describing the chart below.
This preference for U.S. stocks isn’t confined to the retail crowd, the JPMorgan strategist says. In fact, the following charts show Equity Long/Short hedge funds, US balanced mutual funds and Risk Parity funds all increasing their betas to the S&P over the past couple of months.
There are two ways you could read all of the above. If you’re inclined to take a glass half full approach, you could say that the confidence inherent in the rising betas of the institutional crowd to the S&P betrays faith in the outlook and you could interpret the retail pessimism betrayed by the global flows data as a contrarian indicator which, if it turns around, could provide further support.
Or, you could interpret it as Panigirtzoglou does:
Institutional investors’ equity positions are not only far from capitulation levels but, by rising over the past two months, they represent a vulnerability for equity markets going forward if negative news persist.
June was the first month since October 2016 that retail investors turned net sellers of equity funds globally. Could that selling in June be considered a contrarian signal? We do not think so. First, equity fund flows tend to exhibit momentum over long periods of time. Second retail investors are far from being underweight equities.
Draw your own conclusions.
