Will Foreign Institutional Investor Portfolio Flows Continue to Track Global Equities' Performance?
Rolling 12-month flows as a percentage of market capitalization had reached levels only better than the global financial crisis. Somewhat expectedly, flows to several markets turned positive in the past week. While sentiment switches to "bad news is good news," a lag between expectation and appearance of poor economic data may mean the rebound lasts long enough to test investor patience. Could this be the start of a multiyear inflexion?
Most markets – ex-US – have performed poorly over the past five years. From 29% in 2010, the US share of the global market cap has risen to 43%. In the past five years, it has accounted for 63% of incremental market cap, with the rest accounted for by China, Saudi Arabia, and India. The US share of global GDP has been essentially flat in the period, with its share of incremental GDP lagging that of China. The market capitalization-to-GDP ratio has risen sharply in the US (from 95% in 2010 to 160% currently). Still, it has been range-bound in other regions, driven by strong annualized returns, pointing to excesses that could signal mean reversion.
We use indices to look at market returns, which adjust for new listings. The gap between Mcap change and index returns is the widest for China, where the market cap has grown at 10%/5% CAGR in 10Y/5Y, but the index is up only 3%/-2%, respectively. Returns of the US have exceeded that of emerging markets and the EU. While contrarian instincts would point to flows chasing the underperforming markets, given the cloudy outlook of most regions, the likelihood of sustained flows to EMs may remain muted. Asset allocators tracking performance continue to be consistent with the past five years.
Global markets may be rebounding from low levels of risk appetite. The fall in the trade-weighted dollar from multi-year highs corroborates this rebound, despite US’s deteriorating international investment position. At times of stress, the trade-weighted US dollar achieves haven status.