2021: An (Equity) Love Story

2021 will be remembered for a number of things in the minds of market participants.

Most obviously, this year will go down as the year inflation made a comeback. But it’ll also be remembered for a veritable tsunami of inflows into equity funds.

During the first quarter, and into the second, I cautioned against the temptation to extrapolate from weekly inflows. Analysts began projecting a $1 trillion deluge barely three months into the new calendar.

By late summer, though, it was readily apparent that 2021 would be a banner year. With just a pair of exceptions (and only one notable outflow), money flowed into stock funds uninterrupted (figure below).

It was indeed a $1 trillion year. Even if we don’t quite hit the mark, it’s close enough to round up. What’s a few billion between friends, anyway?

As ever, there’s some nuance. “These inflows are not as large as they seem at first glance,” Deutsche Bank’s Parag Thatte and Binky Chadha remarked, noting that if you scale them by overall fund AUM, they sit just at the top-end of the post-Lehman range and are nowhere near levels seen in and around the dot-com bubble (figure below).

Further (and most readers are likely apprised of this), cumulative inflows to bond funds since 2008 far outstrip equity inflows. “For over a decade prior, cumulative inflows into equity funds were essentially zero,” Deutsche reminded clients.

Rather than ask whether inflows to equities will continue unabated in 2022 given a lack of viable alternatives for trillions of “sideline” cash parked in money market funds, it may be more interesting to ponder if the love affair with US equities will persist given this year’s outperformance.

“Of the $900 billion that has gone into equity funds over the last 12 months, $270 billion has gone into the US, with EM, Japan and Europe lagging far behind,” Deutsche’s Thatte and Chadha went on to say, in the same note, adding that “even within international fund flows, the bulk has gone into funds which include the US in their mandate, a sharp shift after several years of flows predominantly into those which excluded the US.”

Several 2022 sellside equity forecasts call for underperformance from US stocks, in part due to the notion that a shift in the macro environment to a regime defined by more robust nominal growth and higher inflation will work to the detriment of the richly-valued secular growth stocks which prospered over a dozen years of “slow-flation.”

As Morgan Stanley’s Mike Wilson wrote in the bank’s year-ahead outlook, “the US’s high exposure to growth stocks means that its relative performance has been inversely correlated to real bond yields in recent years.”

If you think nominal yields will eventually catch up to inflation realities (as opposed to remaining completely detached, as they are now), and you suspect hot inflation will prompt central banks to hike rates, pushing up real yields and triggering a de-rating for expensive shares, the US looks less appealing.

“The reign of QE is ending as the ‘inflation shock’ means hawkish central banks,” BofA said last week, calling credit and FAANG the “epicenter” of an “epic 13-year QE bull market.” The bank’s Michael Hartnett sees “little cracks appearing even before tightening begins.”

In 2021, though, US shares have been tough to beat. The S&P bested global stocks by the most in two decades (figure on the left, below).

A monthly chart tells the story in high resolution, if you will (figure on the right, above).

If you were a government official inclined to measuring your job performance by the stock market, and particularly by the extent to which a given calendar year was defined by American exceptionalism, 2021 was something to tweet about.

There are more tragicomic jokes to tell. About the skewed distribution of equity ownership, for example. And about how, if stocks are an inflation hedge, that unequal distribution means the people most affected by inflation are the least likely to be hedged. But you’ve heard them all before.