This week marks the peak of the first quarter earnings reporting period with nearly 400 companies due to report. Investors have been fairly unimpressed so far, but this might change soon as Deutsche Bank analysts say that the equity market technicals are starting to improve.

Equity market technicals on the mend

Strategist Parag Thatte and team said in their April 22 Asset Allocation report titled “Technicals Improving” that three weeks ago, they described U.S. equity market technicals as “challenging” and predicted that the market would remain range-bound. At that time fundamentals were positive, and now they say the technicals are improving too.

As the first quarter reporting period continues, many companies are exiting their blackout period for discretionary share repurchases. Further, Thatte and team said equity funds have cut back their long positioning from their extremely high levels to become “modestly overweight” Further, the remaining pockets of high short positions declined, with aggregate short interest falling as futures positions and exchange-traded funds lead the way. However, the DB team added that there’s still a lot of room for cash equity short positions to unwind.

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Exiting safe havens

Although equity market technicals have been improving, they said the rotation out of safe havens like cash and government bond funds on the back of improving macro data is benefiting credit rather than equities. They value the rotation at about $122 billion since the beginning of March and have found that almost all of this rotation has benefited high-growth, high-yield and emerging markets funds as equities in general had almost no overflows.

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European and Japanese equity funds have been especially hit hard since February as the outflows move into U.S. and EM funds. The DB team saw that this rotation has partially reversed last year’s big rotation into Europe and Japan as investors expected the monetary policy changes to drive outperformance.

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However, they believe the easing is negatively impacting these regions’ fundamentals, so investors are abandoning their bets in these areas. The DB team thinks the unwinding of these positions still has room to go.

Inflows to U.S. equities still muted

Thatte and team reported also that inflows into U.S. stocks have continued to be “muted” even though equity market technicals are improving and the markets have staged a massive rally. They add that active mutual funds are driving almost all of these outflows, although exchange-traded funds have picked up.

The extremely poor performance of mutual funds (in general) is driving the outflows from them, but the DB team expects these outflows to decelerate and, if mutual funds show sustained improvements in performance, they expect inflows to resume like they did in 2013. So far this month, mutual funds have been outperforming.

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All graphs in this article are courtesy Deutsche Bank.