Follow the money

.

By Guest Blogger Scott Booth

.

Investment performance in 2024 has been a lot better than many investors expected, as advances in the last couple months of 2023 have continued through the first half of the year. Those keeping the faith in all things balanced and diversified have done more than alright…booking returns in the mid-to-high teens over the last 8 months or so, as the prospect of a soft landing has improved (falling inflation, trend-like growth, lower policy rates, and a modest uptick in unemployment rates).

Inflation, while abating, still bites.

Decelerating inflation doesn’t reverse the big increases in the cost of things seen post pandemic.

Remember that quaint idea from some camps of economists that you could print money at will and not spike the price of stuff? Wrong. If one throws enough trillions around it turns out that things can get broken…Like price stability, which if memory serves, is a central tenet to the mandate of most central banks. Oops. While those gobs of cash quickly papered over the impact of covid on financial markets, the end result was a massive surge in prices, which led to higher rates and increased carrying costs that have weighed on the masses.

Some welcome respite is coming as global central banks embark on what is likely a series of policy rate reductions. The Bank of Canada (BoC) and the European Central Bank (ECB) have come out of the gate first, with the BoC delivering its second consecutive cut this week as it dropped the overnight rate to 4.5%. The ECB sat on its hands at their recent meeting but is seems the writing is on the wall that cuts are coming across developed markets. The only questions now are how long we will have to wait for the U.S. Federal Reserve to join the party and how low will they go.

The latest U.S. GDP data released Thursday showed the value of all goods and services produced in the country increased 2.8% Y/Y in the second quarter. The print was a whole lot better than the 2.1% Y/Y growth than economists had predicted and likely gives J-Pow and the Federal Reserve Board latitude to push cuts out until September, as growth accelerated smartly from Q1.

Since the Vid upset the proverbial applecart and put investors on edge back in 2020, a ton of money has flowed into Money Market funds. The war against inflation and ascent of policy rates attracted even more capital…pushing the cash “on the sidelines” north of six trillion dollars.

All the investments in which these funds are parked are about to start paying less, with only the timing, pace, and severity of the decline uncertain. It seems a good bet that a migration from cash is coming, with declining returns incenting investors to seek other options. Expect this to provide a tailwind for both equities and bonds as these funds go looking for a new home.

So where are dollars being directed these days?

Exchange Traded Fund (ETF) fund flows are a good way to gauge what is in and out of favour with investors and provides insights into where capital is being allocated.

ETF inflows in Canada have been massive in 2024, with $9.7 billion of funds flowing into the market in June alone, marking an all-time monthly record for Canadian ETFs and an pushing the year-to-date, record-breaking total to $33 billion. It seems ETF investing is growing in popularity.

Unsurprisingly, Tech stocks, U.S. and International equities have been the preferred destination for funds throughout 2024, but it is interesting to note that Canadian investors pulled funds out of US Equity ETFs in June and there was a surge in demand for Fixed Income ETFs and Canadian stocks during the last month of the first quarter. Word on the street is that substantial institutional repositioning was taking place and that could be a major contributor here.

In any case, headlines touting a “Great Rotation” have been making the rounds of late, as tech stalls and the prospect of falling interest rates improve the outlook for things like Small Caps, REITs and Value stocks. This was expected, and welcome, but waiting for it has been a little painful.

Investors looking to reallocate cash into other fixed income would be well served to ensure they get the risk/reward balance right. Credit spreads, or the additional return one gets for taking on the risk of investing in a corporation are as skinny as they have been since late 2021 (which saw the market test levels last seen in 2007). Investor demand for bonds has been insatiable and so risk premiums have collapsed. It seems investors are being complacent about credit risk. This is not the time to go chase high yield.

This inflection-point of the interest-rate cycle that we are experiencing is likely to result in new dynamics and shifts in investor preferences. The flow of funds in ETFS can provide insights, illuminating how those preferences are being manifest based on where investor dollars are going.

Just follow the money.

Scott Booth, CFA, is a seasoned financial advisor and licensed portfolio manager. Over the past 18 years he has worked in the capital markets as an analyst, trader and advisor with major banks and now with Turner Investments.

.

About the picture: “Relatively new reader here,” writes Erin, “but enjoying immensely. Mary is a 10 yr old blue heeler who loves going fishing to Kitimat, BC so that her supply of canned salmon skins is secured.”

To be in touch or send a picture of your beast, email to ‘garth@garth.ca’