The absence of particularly horrible news, rather than an abundance of good-news stories, has propelled equity valuations around the world. The euro has not collapsed, while the US budgetary shenanigans are being perceived as a political soap opera, spluttered with cliff hangers for the purposes of sheer entertainment, but posing no real threat to the world economy. Even emerging markets, while not growing at their briskest pace, have not come to a standstill. Meanwhile, fixed income and precious metals such as gold have seemingly lost a great deal of appeal over the last few months.
Behavioural economists must be having a field day trying to work out whether investors, who have been pummelled with a relentless stream of negative news over a number of years, are simply fooling themselves or accurately acting on the basis of the new investing mantra, namely 'it could be much worse'.
The fact is that when it comes to Europe, the economic outlook is still best defined by underperformance and uncertainty. UK investors are fully aware that the domestic economy is not particularly sterling (note: pun intended). Meanwhile in the eurozone, most economies face another year of recession and we still don’t know for sure whether the Italian clown (note: no pun intended) might just make Italy (and the euro) ungovernable for the sake of a few laughs. For what it's worth, my own take on the latter is that the clown might personally want to take people for a ride, but won’t be able to. So-called “anti-establishment” movements can only thrive in opposition, but tend to be quickly devoured by the “establishment” as soon as charged with a task where cold pragmatism is required, such as government. In other words, the clown might shout “revolution” from the rooftops, but when his deputies are faced with the choice “euro or bankruptcy”, they’ll probably choose wisely.
Money flow data for exchange-traded products (ETFs and ETCs) in Europe so far this year tell the tale of a re-allocation of investing preferences away from the perceived safety of fixed income and the shiny yellow metal in favour of equity market products. This trend kicked off in the last quarter of 2012, but it is only in early 2013 that we are starting to see net outflows from gold ETCs, a sure fire sign of investor confidence.
Preliminary flows data for the first two months of this year collected by Morningstar show net inflows of roughly €3.6 billion into equity ETFs. This compares to net inflows of €1.1 billion for fixed income ETFs and net outflows of €0.7 billion for commodity ETCs. Digging deeper into the latter data, we find that precious metals ETCs (i.e. mostly gold products) experienced net outflows of close to €1.15 billion, though this was partly offset by net flows of €0.45 billion into other commodity exposures such as agriculture or industrial metals.
Within the equity side of things, investors are favouring large-cap stocks with a broad geographical exposure. Rather than betting on a specific country, the ETFs garnering the strongest interest so far are those tracking indices such the MSCI World, the EURO STOXX 50 or the MSCI Emerging Markets. The preference for broader geographical exposures with a large-cap bias is symptomatic of an investor base willing to dip their toes into equities but doing so tentatively. There seems to be an element of hedging risk involved here.
However, there is always an exception to the rule. In fact, in this case, there are two. ETFs tracking the S&P 500 and Japanese equity indices such as the Nikkei and MSCI Japan have done well. In the first case, European investors are betting on a comparatively better outlook for the US economy, while the second is just the manifestation of the so-called “Abe trade”, or the expectation that the combination of an aggressively loose monetary policy and expansive fiscal one might bring Japan out of its two-decade-long economic torpor.
Initial data so far into March suggest that the rush into equity ETFs has continued; thus auguring well for the asset class in the first quarter of the year. Risk is on. However, in order to declare a full migration into equities, we will probably need the current 'it could be worse' investment thesis to turn into one that says 'it’s actually improving'.
