According to the Morningstar Direct U.S. Asset Flow Update published June 15th, US taxable bond funds had a net inflow of $15.4 billion in May. The report indicates that flows for bond funds were mostly negative last year. Beginning in February this year, flows turned positive after the market volatility in January.
The report also noted that passive equity funds continue to see inflows while actively managed funds continue to see outflows. This data is consistent with the long term trend toward passive and semi-passive investing.
International funds, as a whole, have experienced outflows. The Morningstar report suggests that investors are concerned about potential disruption in Europe if Britain decides to leave the European Union. The referendum will be voted upon on June 23rd.
Mixed economic signals are adding to investor concerns. We had a weak Jobs report for May – just 38,000 net new jobs. However, according to the Atlanta Federal Reserve, GDP is forecasted to be growing at real rate of 2.8% based on the June 14th update for the GDPNow indicator.
Federal Reserve Puts June Rate Hike on Hold
Meanwhile, the Federal Reserve put out a statement today following its two day FOMC meeting indicating that it would keep short term interest rates at their current level. The Fed cited soft business investment, inflation running below their 2% target and a slowdown in labor markets. They did note positive economic data such as growth in household spending. The Fed continues to maintain an outlook for two rate hikes in 2016. This is down from their expectation of four rate hikes as recently as last December. Janet Yellen also commented that British Exit vote (Brexit) was discussed and elaborating that “it’s fair to say it was one of the factors in the decision today.”
What Should Investors Take Away from this Data?
We have discussed several times the relatively weak and sporadic economic growth and the view that rate increases from the Fed would be very small steps compared to past rate increases. Therefore, it is no real surprise to me that the Federal Reserve has pushed out the rate hike.
A British exit from the European Union would certainly cause some short term volatility, but I think weak global growth, recent weakness in sales and earnings growth and relatively stout P/E (price to earnings) ratios are a larger concern. All things considered, Brexit is a minor factor and I wouldn’t lose sleep over it.
How are Brightwood Ventures Model Portfolios Positioned?
Given weakness in developed country growth, our portfolios were already under-weighted in International developed market equities. We are essentially neutral weight on emerging-market equities, given attractive valuations. As a result, the BREXIT should not have a major impact on our portfolio returns.
As far as rate hikes and mixed economic signals, we noted weak earnings growth, gradually rising interest rates and the fact that we are likely in the later stages of the business cycle. Given the valuations of US equities, we moved to a more defensive posture with a bias toward quality companies beginning in January.
All said, the recent mixed signals in the economy and potential volatility in Europe are already factored into our thinking.