Rising bond mutual fund flows could be a bad omen for stocks, says Tobias Levkovich, chief U.S. equity strategist, Citigroup Capital Markets.
"Since earnings are discounted off of long-term government cost of
money, higher bond yields in the future are likely to have meaningful
repercussions for stock prices and thus equity investors need to be
aware and somewhat concerned about the extent of the rush into bond
funds," Mr. Levkovich wrote in a note to clients.
"Indeed, it is the likely upward trend in long bond yields that drive our concern about 2010 S&P 500 performance."
In the United States, mutual funds took in US$377-billion in 2009, with US$357-billion flowing into bond funds. U.S. stock funds, meanwhile, experienced net outflows to the tune of $25.7-billion. Here in Canada, long term mutual fund sales also favour bonds over equities.
Mr. Levkovich said the record flows into bond funds reminds him of the surge in the aggressive growth equity mutual funds during the late 1990s.
That particular buying frenzy ended abruptly when the tech bubble burst, and Mr. Levkovich is worried that a repeat of history maybe close at hand.
"With the government needing to borrow to fund the [US$1.4-trillion] deficit, there's not that much wiggle room for bond investors to look elsewhere for returns," the strategist said.
"Should investors sense that losses will grow as existing portfolios' yields rise, flows could reverse and further exacerbate a rising yield dynamic."