Fund Flows Hint At Cautions On Consumer Status, Best Sectors In Recovery

Includes: AG, AUY, FCX, GG, JJC, MCD, VCR, WPM
by: Emmet Kodesh

A salient fact the last two months regarding the economy and markets has been the plunge in bond prices, now steadied and the rise in yields. Fund flow information for the week ended June 25 reveals unease in the markets and potential problems for economic recovery. The flight from bonds also exposes the true condition of consumer or investor confidence: the light is yellow for caution.

Nearly $79 billion was withdrawn from bond funds and ETFs in late June, far surpassing the $42 billion withdrawn as the credit crisis peaked in fall 2008. Bloomberg noted that most of the retreat from bonds was in mutual funds, holdings by individual investors rather than investment houses. An analyst at Gapstow Capital Partners in NY said "fixed income was there to provide stability and yield … now these are gone." The yield has been paltry for years: the stability the past six weeks has been departing, too. This is even more difficult for most people to accept. It is slowing the move into equities that yield suppression or QE partly is intended to promote.

By the stipulations of the 2010 Dodd-Frank Act, the scale of bond redemptions will require financial institutions to purchase $5.7 trillion in government bonds by 2020. Monitoring the buys will be the Treasury Borrowing Advisory Committee which includes officers from Goldman Sachs (NYSE:GS), Blackrock (NYSE:BLK), JP Morgan (NYSE:JPM), Pacific Investment (PIMCO) and ten other firms. This indicates the extent to which major investment companies and banks are integrated with government fiscal policy and goals. The TBAC and the Dodd-Frank mandate shed light on some otherwise puzzling investment guidance. Clearly it is important to the economy and markets that buying of government debt remain strong: that is the essence of QE and it is starting to falter as the pressure to enter equities at present is not balancing the flight from low-yielding bonds. Treasuries have declined for three straight quarters (3.3% in 2Q 2013) and the plunge in asset value the last 5 weeks has sent investors fleeing to cash.

Also significant was where investors directed the money withdrawn from bond funds and ETFs and the $2 billion withdrawn from equities. Of the combined total withdrawals only $8.17 billion entered equity funds. So about $70 billion went to cash for safety or was used to pay off debt or for living expenses. This does not indicate solid economic strength or consumer confidence.

Since late May when the S&P (NYSEARCA:SPY) twice hit intraday highs of 1674, the index has corrected 3.5% per July 01 rise to 1615. Hopefully this was enough of a correction to resume its up-trend. The S&P rose 215 points from January 3 - May 22 and had gotten 12% ahead of its 50-day MA: the pause occurred as expected, pushed along by worries about QE tapering later this year or early in 2014.

There is added concern from the world's third largest economy after the USA and EU. China's PMI officially dropped to 50.1 in June while the HSBC group of analysts had it dropping further into contraction territory from 49.7 to 48.3, almost as much a slowdown as Italy and Spain. Until the last few days, global stock funds and ETFs have been hit hard the past six weeks as China's growth stutters. The effect has been increased by China's jamming its Prime Rate, the SHIBOR (Shanghai Interbank Offered Rate) from 3 to 10-13% for bank lending. If our prime rate tripled or quadrupled the housing and bond markets would crash and the rest of the economy with it. Yet price action the last three days says that global stocks can shrug off these cautions, at least for now.

HSBC, Goldman Sachs and Barclays have cut their estimate of China's GDP growth to 7.4%, admirable relative to the USA where estimated GDP for 2013 now is 1.8%, if there is no tapering of QE. Remember that GDP is a dubious measure of economic health since it measures all government and other spending and double counts many kinds of income and royalties.

The takeaway is that the economy is not as strong or "the consumer" as confident as the dominant narrative suggests. The movement within mutual funds and ETFs correlates with a succession of regional PMI reports that show the average work week shrinking and industrial PMI falling into negative turf.

Note that consumer discretionary (NYSEARCA:VCR) and consumer staples (NYSEARCA:VDC) funds and companies like McDonald's (NYSE:MCD) and TJ Maxx (NYSE:TJX) have led the recent rise from the intraday low of S&P 1560 on June 24. For cautious investors looking for some growth these and health care (NYSEARCA:VHT) remain the safest areas for investable cash. The sector that has rebounded most powerfully since June 27 from long term malaise and repeated sell downs is Precious Metal miners in which gains of +3% - 9%/day have been numerous. The healthiest of the large cap dividend payers have been Goldcorp (NYSE:GG) +3.66% July 01 and streaming company Silver Wheaton (SLW) +3.15%. Among mid-tiers, Yamana Gold (NYSE:AUY) +3.26 and even more so First Majestic Silver (NYSE:AG) +3.40% have been strong. Look for PM miners to continue to recover from extremely depressed valuations.

A final and very positive note on expectations for short-midterm global growth is the recent rise in the Copper ETF (NYSEARCA:JJC) +3.44% July 01. Freeport McMoRan (NYSE:FCX) +2.44% remains my choice to outperform in all economic conditions. Southern Copper (NYSE:SCCO) +.18 continues to lag its former peer. As a geographic and material-diversified mixed energy and commodity play, FCX should steadily approach its consensus target of $39-40. It has a preponderance of strong buy ratings from 15 major firms from UBS and Barclays to GS, Deutsche Bank and Morgan Stanley. It is paying a special $1/share supplemental dividend this month pursuant to its acquisition of Plains Exploration & Production (NYSE:PXP) and McMoRan Exploration (NYSE:MMR). Its regular quarterly dividend of .32/share is payable August 01.

Disclosure: I am long VOO, AG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.