Besides enriching Reddit traders and making the stock market front-page news again, the world’s cultural obsession with risk-on assets is doing something that has almost never happened in the past three decades. Turning bonds into an also-ran.
That’s true at least in the eyes of retail investors who have traditionally been staunch devotees to fixed income. Yet one of the starkest displays of changing tastes came last month, when investors poured about $20 billion more into equity funds than they did bonds, data compiled by Bloomberg and the Investment Company Institute show. The inflow gap is the best for equities since 2016.
For years, demand for stable returns amid an aging population has put a floor under the bond market along with a dovish Federal Reserve. Now — despite noise like this week’s rally in Treasuries — there are signs a more pronounced alienation is taking hold among fund customers. If it was ever going to happen, it makes sense it’s happening now. So far this year the S&P 500 has gained 11% while Treasuries are down roughly that much.
“As the stock market moves up while bond yields increase, investors are forced to reconsider allocations,” said Jim Paulsen, chief investment strategist at Leuthold Group. “If yields keep rising while economic growth and earnings boom, inflow to equities may get even stronger.”
The new-found affection for stocks is a departure from the past decade where investors funneled money to fixed income. From the 2008 global financial crisis to 2020, equity funds lost $800 billion in stark contrast with the $3 trillion added to their bond counterparts, ICI data show.
The about-face follows the S&P 500’s biggest 12-month rally since the 1930s and what may prove to be the end of a 40-year bull market for U.S. Treasuries. Underpinning the performance is an economy roaring back from the pandemic, propelling corporate earnings to 50% growth this quarter while fueling concern over inflation eating into fixed returns.
The picture is much the same globally, where equity inflows are outpacing bonds by the most in six years. So far this year, almost two dollars have been sent to stock funds for every dollar into fixed income, data compiled by JPMorgan Chase & Co. show.
“It’s just harder to make a rational case for fixed-income assets,” said Arthur Hogan, chief market strategist at National Securities Corp. “It’s consensus view that we’re likely to see higher interest rates.”
The equity buying spree is stoking fear over investor euphoria — though the raw force of the flows may be difficult to overcome. Over the past five months, more than $600 billion has poured into global equities, exceeding total inflows for the prior 12 years combined, according to Bank of America data.
Skeptics point to statistics showing household exposure to the U.S. stock market that is as high as it was at the top of the dot-com bubble, suggesting buyers are maxed out — though the data has some wrinkles. “Exposure” is a function of the overall value of stocks — the two tend to rise and fall in tandem. Saying buying is tapped at current levels is tantamount to saying stocks can’t keep going up because they’ve never been this high before, not always a logical premise.
A look at professional asset allocators shows equity ownership is less stretched. Take the $1.6 trillion hybrid fund industry, where products vary from balanced funds, which maintain a specific mix of equities and bonds, to flexible funds that can put any portion of their assets in stocks, debt or money-market securities. At the end of 2020, the average hybrid allocated 59% to stocks, 31% to bonds and the rest to liquid assets like cash, according to ICI. That’s pretty much in line with their historic average. For context, stock exposure reached 64% in 2004.
It’s unusual to see withdrawals from fixed income — it happened only twice during the past two decades. The stickiness may have to do with the stock market’s tendency to appreciate much faster than bonds during an up cycle, which often leads to an undesirable level of elevated exposure.
For instance, when the S&P 500’s total return reached 51% over the past year while the bond market was broadly flat, a hypothetical portfolio that’s fixed at 60% in stocks and 40% in bonds would have ended up with 70% in stocks, and therefore could be prompted to shift money back to fixed income.
But explosive share gains proved no hurdle during the dot-com boom in the 1990s. Back then, equity funds drew fresh money every year through 2000. Over…