Weakening Fund Flows Threaten Us Stock Rally Due to 'Buyers' Fatigue'

The record-breaking surge in US equities may be showing signs of strain as investors start to pull back from their once-aggressive bullish positions.

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According to RBC Capital Markets, inflows into US equity funds have been muted compared with earlier this year. While recent flows have managed to return to slightly positive territory, they remain far below prior peaks.

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At the same time, both American and European investors have been scaling back commitments to US- and foreign-listed equity funds. Global inflows outside of the US are still positive but trending weaker, suggesting momentum is slowing.

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“When we zoom out, this looks like classic buyer fatigue,” noted Lori Calvasina, head of US Equity Strategy Research at RBC Capital Markets, in a Monday note to clients.

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Calvasina highlighted three headwinds weighing on markets: stretched equity valuations, declining investor optimism, and the seasonal tendency for September to deliver the weakest returns for the S&P 500 Index.

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One particularly troubling trend is the recent slowdown in retail participation. “Within US equity funds, retail flows have faltered,” Calvasina explained. RBC’s data shows that passive inflows from retail investors once a reliable source of strength have actually turned negative in recent weeks.

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Data from Deutsche Bank reinforces this more cautious stance. The bank’s measure of aggregate equity positioning has fallen over the last three weeks, though it still sits modestly above neutral.

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Professional portfolio managers have shifted from neutral to slightly underweight US equities. Meanwhile, commodity trading advisors (CTAs), who use algorithmic models to trade futures and options, cut their exposure to US stocks last week, trimming long positions in both the S&P 500 and Nasdaq 100, according to Deutsche Bank strategists led by Parag Thatte.

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Despite these signs of cooling enthusiasm, US stocks managed to bounce on Monday. After sliding Friday on a weaker-than-expected jobs report, the S&P 500 edged up 0.2% to close at 6,495.15 just shy of its record 6,502.50 hit the prior Thursday. Traders are betting heavily that the Federal Reserve will announce a rate cut next week, fueling Monday’s rebound.

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Still, some desks warn the Fed’s decision could backfire. The central bank meets Wednesday, and analysts caution the outcome might trigger a “sell the news” reaction, with investors locking in profits after the announcement.

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Signals from the options market also hint at growing caution. The five-day moving average of net call option volume calculated as calls minus puts fell last week, Thatte reported. The decline was driven by a steep drop in contracts tied to individual stocks, which sank to their lowest level in a month.

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This pullback in call activity suggests traders are less confident in near-term upside for equities.

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Perhaps most notably, investor sentiment is shifting away from large-cap names in favor of small caps. Options market data shows a steep skew for ETFs tracking the S&P 500 and Nasdaq 100, indicating traders see greater downside risk for mega-cap stocks.

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By contrast, the skew for ETFs tied to the Russell 2000 home to smaller companies remains flat. This implies investors are less worried about small caps in the current environment, according to data from Cboe Global Markets.

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The latest flow data and positioning shifts reveal cracks in what has been a powerful stock market rally. With valuations stretched, retail investors stepping back, and the Fed looming large, traders are bracing for volatility in the weeks ahead.

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While Monday’s rebound showed the market still has buyers willing to step in, the mix of softening inflows, cautious positioning, and bearish options signals suggests the rally may be running out of fuel at least for now.

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