iFlow > Investor Trends
Appearing every Wednesday, Investor Trends provides a deep dive into patterns and behaviors in equity, bond and currency markets around the globe, underpinned with deeper macro insights.
Geoff Yu
Time to Read: 5 minutes
EXHIBIT #1: TOTAL PORTFOLIO EXPOSURES; 60/40 SOVEREIGN DEBT VS. EQUITY SPLIT, NET OF FX HOLDINGS
Source: BNY
Our take
Markets are focusing on shutdown-related risks but with financing of the U.S. government not under scrutiny this time, the bulk of market concern has centered around a prolonged period without any official data releases, and the knock-on impact on policymaking in the U.S. and beyond. The dollar’s reaction function in such a scenario is also uncertain, as there are clear arguments for positivity based on conventional safe-haven flows. On the other hand, if the economic impact is prolonged and the Fed errs on the side of caution, policy differentials could prove more adverse. We still see selectivity as the best path forward tactically. We agree with the narrative that the dollar faced significant hedging flow heading into the September Fed decision, and this will remain a headwind. However, there are also non-U.S. markets which have seen good performance due to previously attractive valuations but that may require de-risking toward year-end. Using holdings data in iFlow, we have identified seven markets which are currently outperforming the rolling 12-month average based on a 60/40 split between sovereign debt and equity asset allocation, but cross-border FX holdings also favor the non-dollar leg (Exhibit #1). Unsurprisingly, carry names across Latin America and Central and Eastern Europe are the strongest performers, but Singapore and Japan also suggest APAC “safety” names remain well held.
Forward look
As the Fed is likely to continue easing in the coming quarters, market sensitivity to carry has increased, and we appreciate the lack of USD purchase flow against currencies such as MXN and BRL. Approaching Q4, we are seeing signs of exhaustion, but the “real asset” protection narrative which tends to benefit high-yielders and commodity-exposed currencies remains in place, complementing current moves in gold. ZAR, for example, has defied strong rebalancing need for several months. All markets listed may face hedging flow to the dollar’s benefit, but cleaner positions where the dollar has a yield and positioning advantage face less resistance, which puts SGD and JPY weakness in play.
EXHIBIT #2: CROSS-BORDER AND TOTAL HOLDINGS IN U.S. EQUITIES
Source: BNY
Our take
Of all the “there is no alternative” (TINA) arguments in the U.S.’ favor, we continue to see the performance of U.S. equities as the strongest. There is little need to revisit the fundamental strengths (tech, AI) of the market, and international investors are also well aware of the challenges, such as concentration risk of some sectors and the prospect of near-term tightening in financial conditions. However, similar to what we observed with Treasury assets in Q2, the ongoing decline in the dollar is being seen as sufficient compensation for the risks in volved. Although cross-border investors’ U.S. equity holdings surpassed the rolling 1-year average from June on, ongoing improvement in price levels of U.S. equities, complemented by flow differentials, has now led to overall cross-border holdings surpassing the combined figure for the first time since March. Furthermore, as of quarter-end the cross-border “premium,” which measures the degree of overweighting by international investors, is at the strongest point to date this year (Exhibit #2). We calculate the level of cross-border holdings as a multiple of the rolling-12 month average, and the corresponding figure for all investors. Currently, the difference is around 1.5pp.
Forward look
Whenever new year-to-date highs are reached, it is always worth looking for the risks surrounding mean reversion. The positive/outperformance case based on earnings growth is clear, along with the macro outlook. For Q4, we continue to see the biggest risk to overseas equity interest in the U.S. as a material tightening in financial conditions, through rate, credit and even FX channels. Any pullback in the pricing of Fed easing will have a broader market impact, but cross-border investors may also find themselves overhedged in dollars at an unattractive valuations point. The bottom line is that if a fundamentally weak dollar was the core driver behind the marginal inflow for cross-border investors, this specific tailwind present through much of the first three quarters may struggle to assert itself through year-end.
EXHIBIT #3: MONTHLY SMOOTHED FLOW INTO U.S. CORPORATE DEBT, TOTAL AND CROSS-BORDER
Source: BNY
Our take
Credit markets are back in focus considering some adverse headlines of late surrounding auto loans and the general state of the U.S. consumer. Markets have become more sensitive to potential vulnerabilities, especially with credit market valuations appearing stretched following the Federal Reserve’s September rate cut. While comparisons with the pre-Global Financial Crisis environment are inevitable, the overall backdrop is considerably stronger, with lower household leverage and more robust banks meaning systemic risks are not the central scenario. Still, the notable surge in flows into corporate credit after years of weakness has drawn attention, particularly as this segment has shown renewed strength without the type of profit-taking seen in other asset classes. The recent momentum suggests room for further gains, even with expectations that the Fed may turn less accommodative. Domestic investors have led this resurgence, maintaining steady inflows throughout the month and showing little inclination to rebalance at quarter-end (Exhibit #2). By contrast, international investors have been slower to return, with cross-border flows lagging domestic participation through much of the summer. Only toward the end of September did overseas buyers appear to re-engage, with modest interest building into more substantial allocations. This dynamic has left foreign investors comparatively underweight relative to their U.S. counterparts, implying scope for additional inflows should valuations remain appealing and risk conditions stable. Together, these developments highlight a credit market that, while still facing pockets of scrutiny, is benefiting from renewed onshore conviction and the potential for offshore demand to provide further support into the year’s final quarter. The shift reflects a nuanced balance between lingering concerns over household and lending conditions and the resilience of broader financial structures that continue to draw capital into U.S. credit.
Forward look
On a holdings basis, domestic and cross-border investors combined look set to end Q3 in a much better holdings position. International investors are slightly less overheld compared to early July, but in absolute terms there is still a sizeable gap in place between the two client groups. We have identified a similar cross-border “premium” in U.S. equities (see above), but this has emerged only recently; cross-border investor holdings of U.S. credit have been solid throughout the past quarter and beyond, but there is just a lack of inclination to add exposures relative to domestic investors.
