The EPFR Exchange Podcast

Ep.99: Inflation rollover, bond funds, and energy

August 15, 2022 Kirsten Longbottom & Cameron Brandt
The EPFR Exchange Podcast
Ep.99: Inflation rollover, bond funds, and energy
Show Notes Transcript

Cam and Kirsten discuss the major flows into EPFR-tracked Bond Funds in recent weeks: Was this guided by an increase in risk appetite? Tightening cycles close to having run their course? Investors feeling we are over peak inflation?  Listen in for answers to these questions and more insight on Sector Funds with flows partly guided by earnings.

Kirsten Longbottom  00:21
Hello everyone and welcome to the EPFR Exchange podcast my name is Kirsten Longbottom and today we're joined by EPFR's resident economist Cameron Brant. Cam, you have some trip coming up next week want to tell us a little bit about it.

Cameron Brandt 00:37
Yeah, so a family trip to Iceland which despite perhaps not unfounded suspicions is not driven by my desire to catch the fish that swim there. I've been hearing for years about the incredible geology and topography. It looks like it's going to be on full display with that volcano erupting there. So yeah I'm looking forward to a visually interesting week punctuated by the occasional smoked puffin and one day of fishing I did negotiate.

Kirsten Longbottom 01:14
I was gonna ask are you sure there's not any fishing thrown in there but good so in terms of fund flows in the latest week the spotlight was definitely put on Bond Funds with groups at the country and asset class levels bringing an end to long streaks of outflows and and pulling in high levels of in flows. Do those interested in high yields bonds which have racked up over $8 billion in the last two weeks have a greater risk for tolerance given our current economic environment?

Cameron Brandt 01:47
I think it's less risk appetite as a simple calculation. If as a growing number of investors seem to feel we are actually or just the other side of peak inflation which you know makes sense, petrol prices though still hig historically have been coming down steadily certainly over here. Growth is slowing which usually takes corporate pricing power with it. And longer-term trends would tend to militate against inflation. You can always create it by really bad economic policy. But assuming we don't stray into that, you do have the Baby Boom generation here retiring which means a large group of enthusiastic consumers are going to earn and spend less, the generations behind them as is frequently chronicled don't have the same capacity to spend and to some degree interest in it. So, what we've been seeing the past couple of weeks is a willingness to bet that the most likely direction for inflation and interest rates is actually down. So if you buy fixed income assets now, you're likely to benefit when the Fed starts to pair back rates. And that calculation even seems to be at play in the eurozone even though they have much more worrying structural issues to deal with. We still started to see some inflows there just after the ECB surprised markets with a 50 basis point hike. But you know it definitely- everything seems to be pointing to a sense that investors feel there's going to be a rollover of inflation and interest rates and hence you know this is a good time to get back in.

Kirsten Longbottom 04:09
We also saw emerging markets end a sixteen week outflow streak in the latest week. Want to talk a little bit more about that as well?

Cameron Brandt 04:21
Well again, you know I think it is driven by this sense that shocking as it has been this tightening period is close to having run its course and that this may well be the point where you want to get in so that you benefit from general improvement. I think in the case of emerging markets there's more risk attached to that just because such a sort of significant minority of emerging markets fall into the distressed debt category and China continues to surprise in not good ways overseas bondholders with its willingness to squeeze sectors that are important issuers, most notably Real Estate. Even though we did see the first inflow in some time, it came through increased flows to the diversified Global Emerging Markets. Which is what you usually see in the first sign of a return to an asset class; people look for the most diversified vehicles first and it's only when they feel the trend is being confirmed that they really start to focus on country level exposure and indeed China Bond Funds continued their fairly dismal run with another week of outflows.

Kirsten Longbottom 06:10
Interesting wow. So China Equity Funds on the flipside, pulled the headline number for all Emerging Market Equity Funds into positive territory while Europe Equity Funds dragged the total for Developed Markets into negative territory. You also noted in the global navigator that China is making a dent so to speak in Japan and Australia's export story. These two regions China and Europe seem to be attracting the most attention in terms of headline news from what I've noticed. Are these spaces to watch in the coming months or are there other standouts?

Cameron Brandt 06:53
If you want something to worry about you're spoilt for choice at the moment and certainly the latest flare-up intentions surrounding China's vision of Taiwan's future which is its reintegration as a province of China has sort of kept the focus there. But from an investment perspective, even though China's growth is markedly slower than it's been for many years and it has some- you know storing up some longer term issues that I think are definitely going to hurt it. It's clamped down on the more dynamic sectors, the reinsertion of the state in many areas of the private economy, the almost reckless loading up of debt to build infrastructure. It remains a large and dynamic economy with a strong domestic demand story and a government that still has policy levers to pool. They still have huge foreign exchange reserves and in the short run when they push a lever, they can make sure people at the other end jump. So you know given that and given there's definite move towards stimulating the economy to try and get growth going again, I think especially emerg- investors with and a stake in or interest in emerging markets feel that that's you know the best place to be at the moment. So we've seen surprising levels of of commitment to China through all of the bumps this year including the complications created by its its extremely unflinching defense of its zero-covid policy. But interestingly this past week we saw a bit more of that conviction back in the sector space which you know we have for some time including first inflows in some time for Industrials and Financial Sector Funds. So that's something you've been keeping track recently. Why do you think there was such a sort of sharp jump to the good this past week?

Kirsten Longbottom 09:53
That's a good question. I think it was mainly guided by a good reporting for earning season. Um, you know with that in top gear so to speak in full swing, we saw ten of the 11 EPFR-tracked Sector Funds report inflows where in previous weeks we've seen more often than not outflows. One of the ones that I noted down was Energy Sector Funds and they just barely broke even into positive territory. But that was mainly guided by Global Energy Sector Funds, while US Energy Sector Funds saw outflows.

Cameron Brandt 10:21
I'm going to jump in here and say you know that's interesting in light of the some of the really spectacular earnings reports that certainly the classic energy majors have been delivering. Why do you think that people have been so cautious about backing that those earnings?

Kirsten Longbottom 10:45
I think it mainly comes from- you know in the energy sector I think people are looking towards longer-term investments at times. So looking towards being better for the climate, cleaner energy focusing on cleaner energy and green energy and actually interestingly in the latest week, the two top funds reporting inflows were solar and clean energy related and despite those great earnings reports from Exxon, Chevron and Shell we saw outflows from a oil gas and infrastructure related fund.

Cameron Brandt 11:25
Not enough of an enduring trend to really buy into especially given the the propensity of governments to dive in and either try and reallocate or forcibly enlist these companies to their anti-inflation crusades.

Kirsten Longbottom 11:42
Right? right? So, in terms of other sectors benefiting maybe from the earnings season. We also saw Commodities and Materials, and Consumer Goods Sector Funds report inflows are rising prices, talk of recession, etc, influencing investors decisions here?

Cameron Brandt 12:05
I would have to think so because a lot of the sort of macro economic picture suggests that people would still want to be exposed to commodity- certainly commodity producers a lot of them have costs in emerging markets currencies but sell their product in dollars which is obviously helpful for the bottom line. Inflation while as I said there's a sizable group of investors who think the worst is over or soon to be over is still a factor and you know the exposure to commodities is a classic hedge against that. In the long-term supply picture is still pretty questionable. There's a- Between sort of the the political imperatives of shifting to clean energy and some more interventionist shifts in the politics of many of the producer countries, Columbia, Chile, Peru, Mexico, are all headed by left-of-center administrations with a much less free market view towards their extractive industries. It does seem to me like a sector that should or a sector fund group that should have been seeing more inflows than it has in recent weeks but perhaps this is the start of a shift to that way of thinking. We'll have to see if more money trickles in the coming week.

Kirsten Longbottom 13:49
Yeah, it'll be interesting to see what next week brings. I think that's all we have time for today. Thank you Cam.

Cameron Brandt 13:59
Yeah, so it will actually be a couple of weeks 'til our next podcast since I won't be around to weigh in the coming week, but we look forward to telling you if some of our predictions today turn out to be true

Kirsten Longbottom 14:17
True. Yeah, it'll be interesting to see all right, bye.