‘Equity vigilantes’ may be pushing the S&P 500 lower

“Equity vigilantes” may be trying to push the S&P 500 lower in the coming weeks just to force the Federal Reserve to stay dovish, analysts at Bank of America Merrill Lynch have warned in their most recent report on capital flows.

The data shows that money left US equities for the fourth straight week, with outflows totalling $3.3 billion last week.

That’s despite the fact that one strategist pointed out recently that currently, US stocks are more attractive from the point of view of valuation than European equities.

Judging by the strength of the flows, if there are indeed such “equity vigilantes” out there, they could well influence the decision to be taken at the March meeting of the Federal Open Market Committee (FOMC), due to their sheer numbers.

Equity vigilantes and capital flows

Equity vigilantes on the rise? Source: Bank of America Merrill Lynch

In its latest statement, the FOMC said: “the Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”

It also reiterated that based on the current conditions, “it can be patient in beginning to normalise the stance of monetary policy.”

Investors have taken these statements to mean that the Fed will stay dovish for a long time, but there is some anticipation in the market that the March meeting could bring a change towards a more hawkish stance.

This may also partially explain why the European Central Bank’s quantitative easing shows signs of working before its official start in March, and even despite the Greek election results and ensuing volatility.

Capital flows data for the week that ended on January 28 show the biggest inflows of capital to European equities since December 2013, at $5.1 billion.

Interestingly, capital went into emerging markets as well, after the ECB’s announcement that it would start buying sovereign bonds.

The data show emerging market equities saw their first capital inflows in 11 weeks, of $400 million.

Bonds have also seen capital inflows totalling $10 billion in the week that ended on January 28.

Of these, the biggest flows, $4.8 billion, went into investment grade bond fund funds. It is the 58th straight week of inflows for this asset class.

High yield bond funds, which last year had the worst year since 2004, also saw a recovery. They received $3.5 billion in inflows last week, the biggest since October 2013.

Emerging markets debt funds, however, saw their eighth straight week of outflows, at $200 million.

Returns year to date weren’t that impressive. Stocks were flat, bonds were flat while commodities lost 8%.

The only asset class that saw a big rise year to date is the US dollar, which has strengthened by 5%.

The Bank of America Merrill Lynch analysts said they remain bullish volatility, which is their number one asset class for the first quarter.

They warn that risks in the energy and credit sector, as well as possible negative surprises in earnings, financial stress or a European failure to respond to lower oil prices “would initiate large risk off asset allocation” in the next six weeks.

@AntoniaOprita