Investors have been snapping up stocks in the bond proxy sectors recently in what looks like a widespread expectation that interest rates will remain lower for longer, according to Bank of America Merrill Lynch. Meanwhile, Tech stocks continued to be buffeted as two of three main categories of investors sold them, and the shift from active investing to passive continues with ongoing purchases of ETFs.
Still selling U.S. stocks
In a report dated June 27, BAML strategists Jill Carey Hall and Savita Subramanian said that last week, their firm’s clients were net sellers of U.S. stocks for the third week in a row. However, the sales among BAML clients started to slow last week, falling to $34 million, the lowest level so far in the most recent selling streak. Net buying of exchange-traded funds grew last week, while single stock sales slowed. The S&P 500 was little changed last week, as it ticked higher by only 0.2%.
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They added that BAML's institutional clients were the biggest net sellers last week, and they've been selling for the last two weeks.
Purchases focused on bond proxy sectors
The BAML team said their clients' flow trends demonstrate clearly the continuing shift from active to passive investing strategies as investors kept buying ETFs but unloaded their single stocks. Among single stocks, the biggest net sales were the two defensive sectors of Staples and Health Care, while the cyclical sectors of Discretionary, Energy and Tech also saw huge sales last week.
They added that the vast majority of the buying within single stocks was in the bond proxy sectors, which are Telecom, Utilities and Real Estate. BAML clients also purchased Industrials stocks. The idea of the bond proxy sectors dates back to the wake of the 2007-08 financial meltdown when the Fed started trying to stimulate the economy by slashing interest rates ultra-low. The result was that the safest investments left fixed-income investors starved for yield, so they became willing to take on a bit more risk than usual.
Telecom, Utilities and Real Estate are the bond proxy sectors because they're seen as a sort of proxy for bonds. It means that stocks in these sectors supposedly carry less risk than those in other sectors, but owning them ideally brings higher yields than bonds during times when bond yields are extremely low. Investors would do well to remember that stocks are still stocks, and they still have more risk than bonds
Focus on bond proxy sectors suggest "lower for longer" mindset
Hall and Subramanian noted that the focus on the bond proxy sectors comes as interest rates keep ticking lower. They explained that the flow trends for the bond proxy sectors compared to trends in other sectors over the last few weeks and even year to date indicate that investors might increasingly believe that interest rates will stay low for some time.
Longest buying trend in Consumer Staples
Despite the challenging fundamentals that continue to impact companies in the Consumer Staples sector, it has the longest net buying trend among BAML clients. They've been buying Staples stocks for the last 11 weeks in a row. However, the BAML team added that the flow sentiment "remains most persistently negative" among Heath Care stocks. The sector's four-week average flows have been in the red since March 2016.
Their firm's clients have also been buying Telecom stocks for the last four weeks in a row. In fact, Telecom is the only sector with a year-to-date cumulative net buying trend among BAML clients. Clearly, this demonstrates that the focus on the bond proxy sectors has been creeping in slowly for some time.
Hedge funds buy Tech, others sell
The BAML team reports that last week was the second consecutive week that hedge funds were buyers of Tech stocks. However, institutional clients were on their third consecutive week of selling Tech, while private clients unloaded Tech stocks for their fifth consecutive week last week. Hall and Subramanian also warned that Tech stocks are at risk this week due to the rebalancing that many funds do at the end of each quarter.
Mutual funds continued to hold their overweight positioning in Tech, which is at the highest level in the history of their data since after 2008. Hedge funds have also been crowding the sector, so it's easy to see why there's so much talk about a new tech bubble.
All three client types unloaded Energy and Consumer Staples stocks, and there wasn't a single sector that all three types purchased last week.
Additionally, pension funds bought U.S. stocks for the fourth week in a row, with ETF purchases being the main driver. They focused their single stock purchases in defensive sectors, and their biggest net sales were in the Tech and Energy sectors.