With the repeated, if brief, Nasdaq selloffs, ETFs are increasingly accused of inflating bubbles in the equity market. I have made a similar argument in “How The ETF Bubble Feeds The Stock Market Bubble.”
However, the real big ETF story of 2017 is not smart beta funds or silly FANG ETFs, but the continued inflows into bond ETFs.
Contrary to the equity market, where inflows into ETFs simply offset outflows from mutual funds, money is pouring into all the funds that invest in fixed income securities. Bond funds have received $1 billion a day since January 2016.
The 2010s bond bubble is the mirror opposite of the 1990s equity bubble. Back then, boomers were in their mid-40s and they needed a large allocation to equities. This mania was rationalized by naively optimistic theories about the “new growth paradigm.”
By the late 2000s, boomers started to retire and they needed income: their appetite for fixed income securities was encouraged by bond-friendly economic theories, such as “secular stagnation” and the “new normal.”
A decade later, the 2010s bond bubble is already bigger than the 90s equity bubble: U.S. households bought $8.9 trillion worth of bonds since 2008, against just $5.4 trillion in equity during the internet bubble.
The internet bubble famously ended when pets.com aired its poorly-timed Super Bowl commercial in January 2000. I do not know which bond issue will eventually epitomize the follies of the 2010s, but I offer a few candidates: the 100-year Republic of Argentina bond that priced two weeks ago.
Or investors getting just 5.3% a year to keep their money in Botswanan Pula for a generation. Or my favorite from the European Museum of Fixed Income Horrors: the Markit iBoxx Euro Liquid High Yield Index, whose largest holding is Russia’s Gazprom bonds, currently on-sale at the jaw-dropping yield of 16 basis points.
One Billion a Day!
To the casual observer, the biggest ETF story of the year would the massive inflows into equity funds. U.S. equity ETFs took in a whopping $177 billion since Trump was elected, versus just $99 billion the year before.
Yet, the real big story happened the fixed income space. Fixed income ETFs issued $112 billion. This represents 17% of assets, versus just 12% for equity funds.
The bond inflows are all the more remarkable since bonds have gone nowhere over the period: the total return of the Barclays Aggregate Bond Index is just 0.9%, versus a gain 17% for the S&P 500 index.
Cumulative Flows into ETFs
Another major difference between equity and bond ETF flows is that the inflows into equity ETFs simply offset outflows from mutual funds.
Equity mutual funds lost $374 billion since January 2015, so the net flow into the asset class has been negligible.
Flows into equity funds
By contrast, bond mutual funds have also been gathering assets – not as quickly as ETFs, but they still took in a net $19.7 billion since the start of 2015. Flows into bond funds accelerated to about $1 billion daily since the start of 2016: this realization should erase any worry about the difficulty of scaling back the Fed’s gargantuan balance sheet.
According to the Fed’s Policy Normalization Principles and Plans, net sales of treasuries from the Federal reserve should start at just $6 billion a month – or about a week of fund demand.
INTL FCStone
Flows into Bond Funds
In addition to steady fund demand, the bond market should besupported by the People’s Bank of China mercantilist policies. After months of selling, the State Administration of Foreign Exchange is re-accumulated U.S. Treasuries. A weakening dollar creates massive demand for U.S. treasuries form all the currency peggers of this world.
