Equities rally may be on shaky ground

The equities rally seen on Friday and which continued Monday morning in Asia seems to have been caused by bargain-hunting following strong outflows over the previous week.

But it is on shaky ground, because the Fed is unlikely to extend its liquidity provisions, so volatility is on the rise.

Outflows of capital from European equity funds hit a record in the week ended on October 15, according to Bank of America Merrill Lynch’s weekly report on flows.

Equities rally could be short lived

Equities rally to reverse? Source: Bank of America Merrill Lynch

At $5.7 billion, outflows from European equity funds were the highest on record, prompting the US bank’s analysts to say there has been a “European capitulation” in the markets.

A pronounced shift towards safer assets took place since the summer, with investment grade and government bonds seeing more inflows, while equities have seen outflows.

Cumulative inflows into investment grade and government bond funds have reached $69 billion this year, while flows into shares are only $19 billion up for the year. Since June, however, more than $25 billion has flown out of stocks.

On Friday, the equities rally was encouraged by St. Louis Fed President James Bullard, who said that the Fed should consider extending its quantitative easing programme beyond the end of October.

Another report into capital flows, by RBS, shows that emerging market equities have continued to see multi-month record large outflows.

In the week ended October 15, emerging markets equity funds saw outflows totalling 0.28% of assets under management (AUM).

It is the second week of significant outflows from emerging market equity funds, with the two-week total rising to 0.61% of AUM.

Outflows from emerging Europe were the worst. The regions saw its largest outflow since February, totalling 0.35% of assets under management, up from 0.27% in the week before.

Even emerging Asia, which has held up better than other emerging areas, saw its biggest outflow since March, with 0.28% of AUM leaving the region’s equities.

In developed markets, the RBS data does not confirm Bank of America Merrill Lynch’s report that the biggest outflows on record took place from European equities. However, it shows that outflows from the asset class were the largest since April 2012.

Both developed and developing market investors favoured bonds over stocks again.

In emerging market bonds, emerging Europe has seen weak inflows, while Latin America and emerging Asia saw some light outflows.

Despite the heightened volatility, which has partly to do with shrinking liquidity, the Federal Reserve is unlikely to reverse its quantitative easing – so the equities rally may turn out to be short-lived.

Economists at think-tank Capital Economics “doubt most Fed officials are worried that global growth is on the verge of collapsing.”

The Fed will not be too worried about the strong dollar if its performance is a consequence of the health of the US economy relative to the eurozone or Japan, so it is “very unlikely” to delay the end of QE.

“Indeed, we continue to expect the Fed to raise the federal funds rate in the early part of next year. And even if we are wrong, we doubt it will delay for long,” Capital Economics analyst John Higgins wrote in a research report.

Another warning that the equities rally is on shaky ground.

@AntoniaOprita

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