Fund Flows Tell Me this Rally May Have LONG Legs

Can this market really just keep going up? I’ve heard and seen several versions of that question on TV, online, and even here in the hallways at Weiss Ratings.

So what’s my take? Sure, we’re overbought in the short term. Yes, valuations are relatively rich. But one thing tells me this stock market rally will ultimately have LONG legs: Fund flows!

Take a look at the chart below. It shows net fund flows – or new money added, minus old money withdrawn – for mutual funds and ETFs. The monthly data comes from the Investment Company Institute, and it’s broken out by category. Bond flows are shown in green, while equity flows are shown in red.

You can see that bond fund flows have been consistently positive for the last several quarters, while equity flows were negative or roughly flat much more often. And this trend isn’t new. Investors have been hiding out in bond funds for the better part of the post-Great Recession period. Equity mutual funds lost more than $412 billion in assets from 2008 to 2015, while bond funds gained just over $1 TRILLION.

What’s more, things really got out of whack last year. Almost $117 billion flowed out of equity funds between January and October of 2016, while $207 billion flowed into bond funds.

I blame everything from lingering institutional fears about the credit crisis to all the talk about a “New Normal” of stagnating growth and never-ending economic malaise. You could also throw in excessive regulations, trillions upon trillions of dollars in global QE, and the panic-inducing meltdown in the energy sector.

But it’s like a switch flipped after the election. All the Negative Nellie talk has been replaced by expectations of accelerating economic growth, profit-boosting corporate tax cuts, spending increases on infrastructure and defense, and widespread regulatory rollbacks. Investors have a new growth thesis they can believe in, so they’re (finally) starting to shift money out of bonds and in to stocks.

The key word there is “starting.” This process has literally been underway for only a couple of months … while the previous bonds-over-stocks phase lasted nine long years!

So sure, we could see a short-term correction as my colleague Mandeep Rai wrote on Wednesday. But the multi-month and multi-year trends in fund flows tell me this rally has legs … potentially very long ones.

How can you profit if I’m right? Well, our Weiss Ratings data and my own research suggest the strongest uptrends can be found in sectors like financials and defense. Technology has also performed well, with semiconductor shares at the head of the pack.

So I strongly urge you to consider some of the ETFs in those sectors that I’ve highlighted recently. You may also want to check out the brand new special report American Arms Bonanza: How to Profit as Trump Spends Trillions to Make Our Military Great Again. Every single one of the five primary stocks I highlighted were trading in open territory as of this week, with two of the five just touching all-time highs.

Until next time,

Mike Larson