Bonds are Attracting Investors Away from U.S. Stock Funds

In the past six weeks, stock funds have seen an outflow of $31 billion, while bond funds have attracted $32 billion in outflows.

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The rally in stocks over the first few months of 2023 has not stopped investors from pulling billions of dollars out of U.S. equity funds in the first few months of the year. The problem is, there's a snag in the plan.

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According to Trade Algo data, $31 billion has left U.S. stock mutual funds and exchange-traded funds in the past six weeks, while roughly the same amount has gone into bonds.

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As Edward Moya, senior market analyst at OANDA, explained to me by phone on Monday, "For a lot of people, this is their first experience trading bonds," he explained. “There are a lot of people who are convinced that you are going to get some yield from this investment in the short term.”

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Barclays data shows federal bond funds in the U.S. have received $32 billion in inflows this year, compared to $18 billion in outflows last year.

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Stock and bond investors were punished in 2022 as a result of the Federal Reserve's aggressive pace of raising interest rates in combination with high inflation. There is no doubt that last year's pain has begun to be replaced by growing optimism about U.S. inflation which appears to be declining and hopes that the Fed might be approaching the end of its rate-hiking cycle as we approach the end of the year.

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Recent economic forecasts have suggested a mild recession for the U.S. this year, or potentially an avoidable one if there is no landing.

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As of now, the Fed has already raised its policy rate to a range of 4.5% to 4.75%, which is its highest level since 2007. It has been suggested by Fed officials that rates may peak above 5% and remain high for a long time, or that inflation may go after it reaches its annual target of 2% for some time to come. All three major stock indexes are higher since early January, despite the possibility that inflation could still play a wild card for stocks and bonds.

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It was a 31% year-over-year gain for the Dow Jones Industrial Average DJIA, -0.64% on Monday, while the S&P 500 index SPX, -0.52% was 7.6% higher to begin 2023, and the Nasdaq Composite Index COMP, -0.47% gained about 13.5% since January, according to Trade Algo.

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With today's higher starting yields, however, the appetite for bonds has increased with the higher start yields for today. The “risk” free 2-year Treasury rate TMUBMUSD02Y, 4.609% was at 4.5% on Monday, while the benchmark 10-year Treasury yield TMUBMUSD10Y, 3.750% was at nearly 3.7% on Monday. According to Dow Jones Market Data, both yields had reached one-year lows in March of about 1.3% and 1.7%, respectively.

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“With the Fed keeping up its inflation fight, it is likely the 2-year will stay above 4% for a while,” Moya said.

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Matthew Bartolini, the head of SPDR Americas Research, pointed out that there has been a similar strength in bond flows in exchange-traded funds, possibly due to a seasonality connected with tax implications that favor fixed income over equities at the end of the year.

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A standout among bond ETF flows has been roughly $6 billion into investment-grade corporate bond funds to start 2023, particularly with yields exceeding 5% in the sector for the first time since the global financial crisis.

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The largest of these funds, according toTrade Algo, is the iShares iBoxx $ Investment Grade Corporate Bond ETF, LQD, -0.35%, with its shares up 2.5% on the year so far, according to Trade Algo.