As ‘exodus from Europe’ intensifies, watch the UK savings ratio

The list of reasons to worry in the market is growing longer by the day, and investors keep taking money out of risky assets – among them, European ones.

The phenomenon has been dubbed an “exodus from Europe” by analysts at Bank of America Merrill Lynch, who say there is “no surprise that the outflow from European high grade and high yield funds has been much more sizable than outflows from emerging markets debt funds.”

They named the lack of a yield in Europe compared with more attractive yields in dollar assets as the main reason for the flight from European risk assets.

Capital flows data show that in the past 36 weeks, European equity funds experienced 35 weeks of outflows.  However, there is light at the end of the tunnel: at $1.3 billion these were half the size of the week before.

In equities, the only two places that saw inflows were the US, with a small $2.6 billion going in, and emerging markets, which with $1.2 billion saw their fifth straight week of inflows.

In credit, things are more dramatic. This year, investors in fixed income assets, mainly bonds but also other types of debt, experienced a sharp reversal of their fortunes as most bonds’ prices fell.

Last week, investment grade bond funds saw outflows of $2 billion, while high yield bonds saw $2.3 billion going out. Emerging market bonds saw smaller outflows, of just $600 million. Even Treasury Inflation Protected Securities (TIPS), which are seen as a way to protect against rising inflation, saw $500 million in redemptions.

When it comes to the debt situation, perhaps the most dangerous place is the UK. Societe Generale’s Albert Edwards, renowned for his bearish views, highlighted the slump in the UK savings ratio compared with those of other economies.

“While so many commentators focus on Brexit uncertainty, the plunge in the UK saving ratio is probably one of the single biggest global macro imbalances to have emerged in the last few years — and one which will likely sink the economy,” Edwards said.

The UK has a household sector deficit, which is due to the fact that the central bank has maintained an ultra-loose monetary policy for a very long time. Even now, although it has raised interest rates two times, the current level of 0.75% is still in negative territory in real terms, with consumer price inflation running at 2.2% and house price inflation at more than 3%.

“Sustaining an economic recovery by encouraging extremes of private sector borrowing inevitably ends up with asset bubbles bursting and sharp rises in the savings ratio, causing recession. The UK will be no different,” said Edwards.

With all these reasons to worry weighing on investor sentiment, the Bull & Bear Indicator, which is a contrarian indicator, could be expected to trigger a Buy signal soon.

Bull and Bear Indicator

No Buy signal yet. Source: Bank of America Merrill Lynch

However, while close, the indicator still has not hit the contrarian Buy level. Only two of its six components are now outside bearish territory: credit market technicals, which are bullish, and hedge fund positioning, which is very bullish.

But perhaps, just like markets can remain irrational on the upside for a long time, they can do the same on the downside. There may be a while before the indicator swings the other way.

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