A preference for equities over credit
We view crowding as a sign of heightened risk rather than a signal to sell. There have been significant flows into exchange-traded products and mutual funds across asset classes this year, as perceived economic and political risks have declined and many investors have put cash to work in response. Nearly $170 billion has flowed into global bond funds year-to-date, and $140 billion into global equity funds, EPFR Global data show. At the same time, money market funds have experienced notable outflows.
EM and European stocks are no longer the contrarian trades that they were for much of 2016, but we believe there’s still a strong case for exposure to international stocks. Our “risk ratio” gauge of risk appetite is at levels consistent with moderate risk taking, but nowhere near the “irrational exuberance” seen in the late-1990s or mid-2000s. Strong inflows year-to-date have only replaced a quarter of the outflows from EM stocks between the 2013 “taper tantrum” selloff and mid-2016, and only 17% of the flows out of European equities last year.
Global reflation, a strong earnings recovery and attractive equity risk premiums also should support international stocks. Against this backdrop, we prefer taking risk in equities over credit, where positioning is more crowded and valuations less attractive, though we do see opportunities in high-quality U.S. credit.
