October 6, 2017 / 10:35 AM / 10 months ago

More record highs to come as tax reform hopes drive flows - BAML

LONDON, Oct 6 (Reuters) - Stock markets are likely to hit new highs, BAML strategists said after a week of records on Wall Street, joined in Europe by Germany’s DAX which reached a fresh peak on Friday.

After the sixth consecutive record close for the S&P 500, an all-time high in high yield bond returns and an all-time low in the VIX volatility index this week, strategists said markets could yet climb further.

In a note titled “All-time highs, small-time flows,” strategists said that despite these levels investors were not piling into equities and high-yield bonds at an exuberant rate, remaining cautious of a widely anticipated fall from highs.

“Magnitude of high beta inflows (equity and high-yield = $6.4 billion this week) well below the $50 billion a month needed to trigger ‘sell’,” they wrote in a note to clients.

Some $5.1 billion flowed into equities this week while $9.5 billion went into bonds, according to EPFR data cited by the bank.

Equity flows indicated investors were starting to anticipate a tax reform package from the U.S. administration, strategists said, pointing to the biggest inflows to financials in 13 weeks.

Bank stocks have been the most sensitive to signs a promised tax reform package would materialise, reigniting the “reflation trade” which sent stock markets surging after the election of U.S. President Donald Trump.

A rotation out of U.S. large-cap stocks and into small-caps gathered pace, another return to post-election patterns which saw investors pile into U.S. small-caps seen as big beneficiaries of tax cuts.

Small-cap funds drew $0.6 billion while large-caps lost $3.4 billion this week.

Exchange-traded funds retained their dominance in equities, drawing $9.4 billion while $4.3 billion flowed out of mutual funds. Assets under management in the index-tracker products have ballooned 12.6 percent this year, while long-only funds’ assets fell 1.8 percent.


Rising U.S. Treasury yields drove the largest outflows in 31 weeks from Treasuries, as expectations of a U.S. rate increase have become more entrenched in bond markets.

Floating-rate loan funds, meanwhile, drew their largest inflows in 12 weeks as investors sought to protect bond investments from expected Fed rate hikes.

However, the biggest investment-grade bond inflows in 17 weeks was a sign of a “no fear of the Fed” sentiment, strategists said, with investors continuing to hunt for yield.

As calls for stock markets to fall from their current highs multiply, BAML strategists saw several triggers for the equities bull run to disintegrate.

“Marketing indicates that correction requires jump in rates, which in turn requires higher inflation/wage prints, passage of tax reform,” they said.

A jump in bond yields and the MOVE index of bond market volatility should be expected in the next three months, they added.

Market structure was also a concern, with clients worried about volatility selling strategies, quantitative investing, and ETFs.

BAML’s “Bull-Bear” indicator of market sentiment rose to 7 as hedge fund positioning turned more optimistic and the credit market remained strong, but strategists said many European investors were looking, or hoping, for a correction.

Reporting by Helen Reid, editing by Ed Osmond

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