Stock Market Insights: Market Signals – Yellow Flags in Stock Market

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Photo courtesy Richard L. Baker

I think there are two kinds of people in the world: those who hit the brakes when they see a yellow light and those who hit the gas. I’m a person who doesn’t slow down for yellow lights. I think the stock market light is turning yellow, and I’m watching to see what investors do about it.

Investment fund flows, which measure the movement of cash in and out of investments, can reveal patterns in investor sentiment and general investing trends. As I sifted through the May fund flow activity, I noticed a trend: a drop in investor appetite for risk.

Examining the Morningstar category data in May, large blend equities had the most inflow by a huge margin. Investors poured more money into large blend equities, continuing a trend we’ve seen all year as they moved money out of large growth equities to a historically lower-risk category.

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An eye-catching stat is that the next four categories and seven of the top 10 categories by inflows are bonds as investors continue the trend toward lowering risk. Intermediate core, ultrashort, high yield, and global bond-USD hedged bonds had big inflows in May, according to LPL.

Where was the money moved from? Mid-cap growth had the most outflows over a few other classes, including healthcare. Of course, it’s no surprise there are outflows from healthcare, with its weak earnings, slowing COVID-19-related sales, and Medicare continuing to decline so many patient reimbursements.

This trend of seeking less risk is a directional change from the end of March when equity allocations reached a 15-year high due to soaring stock returns. The drop in risk is elsewhere; Cryptocurrency Funds have had their second-largest outflow year-to-date, and Emerging Markets Bond Funds are seeing consecutive weekly outflows.

Yellow flags have cropped up across the stock market over the past few weeks as the economic data has softened quickly. With the inflation reports continuing to stay high, I can’t see the Fed lowering rates before September. That leaves us with a two-month window for the stocks to prove these high stock prices, which might be difficult without the economy reviving. I wouldn’t be surprised if the markets had some volatility before the Fed starts lowering rates. I feel good about how the market will end the year but expect some interesting days with the two-month window before the Fed lowers rates, the usual presidential “October Surprise,” and the actual election.

I’m not putting up a red light, but I am starting to ease from green to yellow. I am slightly overweight large-cap equities over small-cap equities, neutral on fixed income as far as duration, and favor fixed income over cash with the nice current yields. I’ve also downgraded healthcare to underweight for several reasons, including some potential presidential election risk.

I am an aggressive driver. I shoot pretend missiles at passive drivers who break too soon or drive in the left lane daily. When I see a yellow light, my first instinct is to go through the light, but sadly, I am at the mercy of what the car in front of me decides to do. I’m seeing yellow in the market and many opportunities, but like driving, just how much opportunity will depend on the staying power of other investors. Somehow, I married a cute girl who hits the brakes at yellow lights. I appreciate your prayers about that.

Have a blessed week!

www.FerventWM.com

Dr. Richard Baker, AIF®, is the founder and executive wealth advisor at Fervent Wealth Management.

Securities and advisory services offered through LPL Financial, a registered investment advisor, Member FINRA/SIPC.

Opinions voiced above are for general information only & not intended as specific advice or recommendations for any person. All performance cited is historical & is no guarantee of future results. All indices are unmanaged and may not be invested directly.

The economic forecast outlined in this material may not develop as predicted & there can be no guarantee that strategies promoted will be successful.

Fervent Wealth Management is a financial management and services entity in Springfield, Missouri.

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