Danger Ahead Or The All-Clear For Stock Markets?
Capital Flows Out Of Bonds While Inflows Into Stocks Remains Steady
Historically, the behaviour of bond markets has often served as a leading indicator for the stock markets.
Bonds react more directly to the changes in interest rates that often precede economic expansions and recessions.
The current cycle of aggressive rate increases by central banks has been reflected in the negative performance of both stocks and bonds thus far in 2022, but an interesting divergence between the two markets has developed in recent months.
The accompanying chart illustrates that there has been a marked decline in capital flows into bonds while capital directed into stocks has been flat with a slight upward.
That significant capital flows are still being directed at both markets (given current circumstances) is likely attributable to the ongoing popularity of passive investing strategies and investor apathy.
We have commented previously on the remarkable (at least to us) level of investor optimism that still exists in a notably unattractive risk/reward investing environment. We pointed to the relatively benign behaviour of the Volatility Index (VIX) thus far in a turbulent 2022 as an indicator of investor optimism. The capital flows in the chart make the same point.
The bullish interpretation of the accompanying chart would say that equity investors are signalling that we are near the end of rate increases and that the bear market in stocks has ended or will end soon.
A less sanguine view would be that the chart reflects the absence of the necessary extreme of investor bearishness that has historically marked the end of bear markets and that equity markets must eventually exhibit further significant weakness before we see evidence of an extreme of investor bearishness that typically produces an attractive buying opportunity.
We view the current investment climate as presenting a less than compelling risk/reward. However, we are optimistic that there will eventually emerge great risk/reward opportunities for the prepared, informed investor. The volatility which we believe will come to define the 2020s will punish the inattentive, passive investor.
Each month in the Global Investment Letter I update my investing activities, as well as comment on major global equity, fixed income, currency, and commodity markets.
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