While it might not seem like it, we’re in the midst of a stock market rally.
On Tuesday, the S&P 500 Index touched its highest point in more than four years and major European markets edged higher on hints of progress in solving the region’s sovereign debt crisis. Admittedly, it might not be the strongest of rallies with many traders complaining of weak volume and narrow gains, but it does mark the year’s second rally.
So, where are investors choosing to take on risk today? And how does it differ from the beginning of the year, when global stock markets rallied in January and February?
To answer those questions we decided to compare ETF fund flows during the two time periods. We studied flows from January 2 until February 29, and compared those to flows from June 1 until August 17. Granted, we know this isn’t a true apples-to-apples comparison because the time periods are not identical, but we were still curious to see what we could glean from the numbers.
First, let’s look at areas where we found similarities:
In both rallies, utility stock ETFs — considered a defensive play — saw outflows. Investors also moved from traditional safe-haven investments like US Treasuries into investment grade corporate bonds.
Now, let’s look at areas where flows have diverged in terms of where investors are choosing to take on risk:
At the start of the year, investors put their dollars to work in emerging market (EM) equity funds. The sector attracted $12.3 billion of inflows in January and February, but in the most recent rally it has attracted just one-third of that amount. US small-cap and US mid-cap stock funds also attracted inflows at the start of the year, compared with recent outflows.
Meanwhile, funds are now flowing into a sector that many investors bypassed earlier this year – European equities. Since June, European equities have attracted $4 billion of inflows, compared with $0.2 billion of flows during the rally at the start of the year.
The flows appear to show a muted risk-on environment, where investors are taking a selective approach to risk. The reason we say muted is that these latest European flows are still modest by historical standards. For instance, European equity funds attracted $5.6 billion of inflows in July alone of last year.
The numbers remind us that risk-on is not a catch-all phrase, and market rallies come with their own shades of risk taking. But the flows are indicating that while we might not be in a vigorous risk-on environment, risk sentiment is improving among investors.
Dodd Kittsley, CFA, Director, is Head of Global ETP Market Trends Research for BlackRock.