Investors are abandoning stock funds with alacrity as the reality of the potential fallout from a protracted trade war with China moves from speculation or posturing to reality. As restrictive trade measures have already been implemented by President Trump, the uncertainty about the economic extent of the fallout has pushed many investors to seek the security and safety of less risky assets such as bonds.
According to data provider Morningstar LLC, long-term stock mutual funds and exchange-traded funds experienced a $20 billion outflow this June, making it the third-worst first half for equity outflows over the past 10 years. The trend hasn’t slowed: according to the Investment Company Institute, investors redeemed more than $11.6 billion from domestic stock funds in the three weeks ending July 18.
The exodus is occurring against the implementation of the first round tariffs imposed on China. Ironically, it also is transpiring during a period of robust corporate earnings and continued strong economic growth that has propelled the S&P 500 to a 6.5% return this year. At first blush, given the higher returns the market has produced relative to rates on bonds, pulling money out stocks may seem foolhardy.
Nonetheless, many investors feel a 10-year uninterrupted rally in stocks, ongoing market volatility and newfound uncertainties about the ramifications of a trade war all warrant a re-examination of whether a stock-heavy allocation in their portfolio is prudent in light of the potential hazards from a looming trade war.
There is little doubt that had the market’s performance been lackluster, outflows from stock-based mutual funds and exchange-traded funds would have been more pronounced. The market has been buoyed by strong reported corporate earnings.
Another significant reason for the shift is investors are no longer reticent about leaving stocks as they once were during the decade-long unprecedented bull market, as the relative returns between equites and bonds was heavily weighted in favor of stocks. Due to the long period of quantitative easing, the total return from the S&P 500 far outweighed any comparable returns available from straight fixed-income investments.
Those halcyon days are over. The federal reserve has been raising rates since the beginning of the year and has announced that it intends to continue raising rates as the economy and historically lower unemployment start to exceed their targets.
Bond returns are no longer negligible relative to equities. An inverse bond-equity relationship that was prevalent during the past 10 years created an environment where the S&P 500 was like a minimal risk savings account. The market was remarkably stable and its trajectory was always upward.
In a rising interest rate environment, the real return now available on bonds has completely readjusted the risk-reward equation for investors and made the exodus from stock funds much more palatable.
Disclosure: I have no positions in any of the securities referenced in this article.
