Bonds? We Don’t Need No Stinking Bonds!

by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Summary: Investors have been piling into all-equity one-ticket solutions. Performance chasing, perhaps. These vehicles are more tilted to DIY investors as this trend is less evident across the broader market flows. The all-equity may prove challenging as the post-election honeymoon fades with sentiment and positioning extended.

Suppose it should not come as too much of a surprise, but investors have been loving equity exposure lately. In 2022, bonds and equities both dropped double digits, call it 15-20%. That is an expected occasional experience from the equity side of the portfolio, but those bonds were supposed to be the ballast during troubling times, and they clearly dropped the ball. Given this experience was followed by two years of really strong equity market returns, recency bias appears to have kicked in big time.

This behaviour is very evident in the single-solution ETF market in Canada. The flows into all-equity one-ticket solutions have ballooned higher over the past few years while the appetite for more ‘balanced’ solutions, even the ‘growth’ tilted portfolios, has lagged. The chart below shows the trailing six months of flows into a handful of these ETFs, broken down by asset class mix. All equity flows have generally been tracking double the others. We could have included the flows into ‘conservative’ tilted solutions, but it barely registered on the chart.

We don't need no bonds

Can you blame investors? Global equities have appreciated by 22% annualized since the start of 2023. And since the election, markets have bounced even higher, led again by U.S. equities. The S&P 500 briefly had a 6,000 handle. Investors have become exceptionally optimistic. Take your pick – AAII sentiment of bulls at 50% eclipse bears at 28%, which has the undecided remarkably low. We should note the bulls have been consistently outnumbering the bears for a while, and the market has gone up. This is a survey, though, and surveys are not as reliable it seems… kind of like political polls.

Looking at where the money is, this is perhaps a bigger concern. Over the past month, the trend has been for more investors to place bullish bets or positions on equities and more bearish positions on bonds based on the futures and options market. These trends seemed to accelerate following the election results – now maybe getting to rather extreme or extended levels.

Speculators vs bond speculators

A few reasons it is worth paying attention to futures/options positioning. When overly tilted in one direction, like everyone bullish or bearish, things can reverse very quickly. One, because if everyone (or most everyone) is bearish, it is harder for more people to become bearish. For example, if 100 people include 90 bears and 10 bulls? Well, there are only 10 people who could change their minds and add to the bears. But there are 90 that could add to the bulls. There is a mechanical factor as well. When an investor puts on a bearish futures/options position, the folks facilitating this will hedge their side by shorting a bit. As such, when those positions start to unwind, the dealers tend to feed the momentum as they unwind their hedge.

Pretty extended sentiment and positioning raise the risk of a counter-trend move in markets. That would be lower for equities and higher for bonds. Maybe it is starting today (Friday) as we write this Ethos. Sure is a poor end to the week.

Another factor to consider is who is doing the buying. Our first chart was fund flows into single-line solution ETFs. While both DIY investors and advisors use these vehicles, it is tilted much more towards DIY. Switching to U.S. data that tabulates all ETF & mutual fund flows, it would seem there is lots of money flowing into both. Perhaps this is the most insightful piece. Could rampant performance chases be primarily by DIY investors while advised investors are allocating with a more balanced approach?

US flows in 2024

This may be apples and oranges, as the DIY investors piling into more all-equity solutions may be, on average, younger with longer time horizons compared to the dollar-weighted average age of all investors. Still, a proxy for more retail flows does appear to be very ‘all-equity’ tilted – which has also been the right call over the past year+.

Final Thoughts

Perhaps we are in the post-election honeymoon phase, as it did remove uncertainty from the market. And we can argue that at this time of year, markets go up more often than down. But come January, when the headlines start to fly, the market could easily become more fragile to headlines it doesn’t like. We expect this to be a more volatile time as the market becomes accustomed to headlines. And then there is tax. Many investors, sitting on gains thanks to the past two years of outsized gains, may be waiting to sell in the new year to defer the tax hit a bit longer.

Markets: they are always entertaining one way or another.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

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Sources: Charts are sourced to Bloomberg L. P.

The content of this document is for informational purposes only and is not being provided in the context of an offering of any securities described herein, nor is it a recommendation or solicitation to buy, hold or sell any security. The information is not investment advice, nor is it tailored to the needs or circumstances of any investor. Information contained in this document is not, and under no circumstances is it to be construed as, an offering memorandum, prospectus, advertisement or public offering of securities. No securities commission or similar regulatory authority has reviewed this document, and any representation to the contrary is an offence. Information contained in this document is believed to be accurate and reliable; however, we cannot guarantee that it is complete or current at all times. The information provided is subject to change without notice.

Commissions, trailing commissions, management fees and expenses all may be associated with investment funds. Please read the prospectus before investing. If the securities are purchased or sold on a stock exchange, you may pay more or receive less than the current net asset value. Investment funds are not guaranteed, their values change frequently, and past performance may not be repeated. Certain statements in this document are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend on or refer to future events or conditions, or that include words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” intend,” “plan,” “believe,” “estimate” or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are, by their nature, based on numerous assumptions. Although the FLS contained in this document are based upon what Purpose Investments and the portfolio manager believe to be reasonable assumptions, Purpose Investments and the portfolio manager cannot assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on the FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.

 

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