Road to Recovery Playbook Factor #4: Pessimistic Sentiment

Market Blog

We’ve been monitoring the details in our Road to Recovery Playbook closely over the past few weeks, looking for ways to opportunistically take advantage of the sharp pullback in equity prices. The Playbook has five important factors we are scrutinizing in order to be more aggressive with equity allocations. One of those factors emphasizes whether we believe there are limited sellers remaining. For clarity on that particular factor, we reviewed recent statistics from Morningstar on fund flows, and we found some interesting observations.

As shown in the below chart, investors have acted as if money markets are king, essentially selling exposure to everything else to fuel increases in allocations to money markets. Looking closer, the statistics show that investors have started to sharply reduce exposures to higher-quality taxable bonds and municipal bonds, sending the message they don’t think even those categories are safe enough in the current market environment. The weekly outflow from municipal bonds was a record, and it was nearly three times the size of the previous record set in mid-2013.

Interestingly, those outflows from taxable and municipal bonds were much higher than outflows from equities, perhaps pointing to some exhaustion on the part of those investors who had been reducing equity exposure in prior weeks. In our view, investor sentiment toward equity investments is certainly low at this point, US equities appear oversold, and there is attractive potential for a rebound in equity prices over the next several months.

View Expanded Chart.

“Although COVID-19 developments have caused some investors to shift allocations toward money markets, we recommend investors stick to their long-term investment plans” said LPL Financial Managing Director and Chief Investment Officer Burt White. “The roughly 30% drop in the stock market has approximated average historical declines tied to bear markets and recessions, and our Playbook may be close to signalling an opportune time to increase equity exposure.”

The fund flows data from Morningstar certainly points toward tepid stock market sentiment at this time, helping us build confidence that the number of sellers is dwindling. We continue to monitor our Playbook closely, particulary the first factor that focuses on line of sight into a peak in the growth of new COVID-19 cases in the United States. The ingredients for stocks to carve out a bottom and trend higher could be coming together nicely.



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