April Ushers In Cyclical Divergence Between S&P and Treasury

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Equity markets, as measured by the S&P 500, have surged to new highs while the U.S. 10 year Treasury yield has approached fresh year to date lows, an uncharacteristic divergence; according to Deutsche Bank AG (ETR:DBK) (FRA:DBK) (NYSE:DB). Equity investor flows to long short funds and equity mutual funds have slowed. In contrast flows to fixed income vehicles have accelerated and investors have positioned long primarily. Demand for U.S. Treasuries was met with basically net zero issuance in April as tax receipts surged.

April Ushers In Cyclical Divergence Between S&P and Treasury

Deutsche Bank AG (ETR:DBK) (FRA:DBK) (NYSE:DB) analysts explain that while equity flows show a small overweight of 0.5 standard deviation (sd) above average, such number is low relative to prior spring peaks of 1-2 sd above average. Investors are hedging their equity exposures by investing in long short funds and macro funds. Equity mutual funds are just about 2 percent overweight. According to Deutsche Bank, if equity betas reach 0-0.5 during the summer, long equities could experience a 6 percent correction. Given investors’ positioning, illustrated below, a 4 percent correction is likely if flows remain flat.

According to Deutsche Bank’s study, hedge funds are overweight cyclical sectors while mutual funds are overweight consumer discretionary and financials. Mutual funds are underweight technology and energy. Regionally, developed markets and global funds are overweight while emerging Asia and Latin America are underweight. Europe mutual funds have experienced their ninth consecutive week of outflows.

positioning by investor class

us equity vs performance

Deutsche Bank AG (ETR:DBK) (FRA:DBK) (NYSE:DB) analysts expect equity flows to follow historical patterns this year of slowing down after April and then improving over the fall. The main driver is the slower reallocation from money market funds to equities, and to a lesser extent, the underperformance of equity mutual funds. Since mid-January, money market funds have experienced outflows of $170 billion. Some outflows from equity mutual funds will likely be recaptured by equity ETFs, continuing a 6 year trend.

U.S. Treasury Yield Decline In 10 Years

Regarding fixed income, Deutsche Bank AG (ETR:DBK) (FRA:DBK) (NYSE:DB) believes that the decline in the 10 year U.S. Treasury yield coincided with the lack of issuance in April. Deutche Bank analysts believe that yields will likely rise as the Treasury will resume issuance between May and July, when tax receipts experience seasonal declines. In turn, rates will likely rise from their lows pressured by more issuance and unwinding of long rate positions by macro hedge funds.

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