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Follow the money

Follow the money Mindful Money

As markets have anticipated a moderation in aggressive central bank policies and interest rates have risen, investors have redeemed substantial sums from fixed income open end mutual funds (see Figure 1). Since the end of May, over $25 billion has been pulled from traditional, interest-rate sensitive bond funds (such as government, corporate, emerging market and high yield debt), while over $11 billion has flowed into funds that have more flexible strategies, like absolute and total return funds, or funds that offer some protection against rising rates, like floating rate and loan funds (figures based on a subset of funds which provide weekly data). Given that the assets of the flexible funds are substantially smaller than for the traditional funds, the inflows are even larger as a percentage of assets. The rate of redemption from traditional funds has slowed recently, however, as central banks have tried to assuage concerns that policies will be tightening any time soon. Better than expected economic growth could push rates up anyway, possibly leading to further withdrawals.

Figure 1: Flows to US-domiciled fixed income open end funds
Figure 1: Flows to US-domiciled fixed income open end funds[/caption]

Last data 10 July 2013. *Absolute, total return, floating rate, and loan funds. **Government, inflation-protected, corporate, emerging market, and high yield bond funds. Source: Morningstar, J.P. Morgan Asset Management.

As investors take profits and reallocate their cash, much of this money is going to emerging market (EM) equity funds (see Figure 2). The enthusiasm for emerging market equities may seem surprising given their poor performance this year, with EM having dropped by nearly 8% (local currency terms, price index only), compared to a gain of almost 14% for developed market equities. Rising US interest rates also pose a threat, as better yields in developed countries tend to draw flows away from emerging markets. Relative valuations favor EM, however, and a belief that the under-performance is a temporary phenomenon seem to make a convincing case that currently low prices offer an attractive entry point. We concur.

Figure 2: Cumulative flows to US-domiciled equity open end funds
Figure 2: Cumulative flows to US-domiciled equity open end funds[/caption]

Last data 10 July 2013.  Source: Morningstar, J.P. Morgan Asset Management.

China growth

One of the key drivers of emerging market equity under-performance has been disappointment over the pace of growth of the Chinese economy. Recent trade figures, both for imports and exports, have missed forecasts, and comments from officials suggest that even the government itself is lowering its expectations for the economy’s potential.

Recent second quarter GDP figures help to bolster the case of either the pessimists or the optimists depending on their bias. The growth rate came in as expected (7.5% year-on-year, down from a 7.7% growth rate in the first quarter), but the economy is nonetheless improving (see Figure 3). Looking at quarter-on-quarter growth rates, the GDP figures show that activity has picked up after a disastrous result in the first three months of the year. For that period, the quarter-on-quarter (annualized) growth rate was just 6.6%, a dramatic drop from the 8.2% pace the economy had at the end of 2012. Even though the quarter-on-quarter figures are seasonally adjusted, there was a similar dip in the first quarter of 2012, which was followed by much stronger growth the rest of the year. The latest q/q figures show growth was 7.4% in 2q13. While this is still below the 8% that at one point was considered the minimum acceptable growth rate, it would indicate a stabilization in the economy that could provide some support for the equity market.

Figure 3: China GDP growth
Figure 3: China GDP growth[/caption]

Last data 12 July 2013. Note: Quarterly data seasonally adjusted. Source: National Bureau of Statistics of China, Bloomberg, J.P. Morgan Asset Management.

This article was written by Dan Morris and originally published in Mindful Money under the title: Follow the money

Tags: bonds , central bank , emerging markets , government , interest rates , investments , money
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