The Tell: U.S. stocks benefiting from ‘sense of urgency’ as investors rush into equity mutual funds

Getty ImagesThe individual investor is back and heading into equity mutual funds, where the chase for upside is in “full swing.”That’s according to a team at Barclays UK:BARC. In a note released Tuesday, they outlined a number of reasons that are likely to add up to a continued rally in U.S. stocks despite lingering macroeconomic risks. Among other things, individual investors are buying equity mutual funds, which in turn are scrambling to extend their exposures to U.S. stocks. Data provided by Barclays illustrates this, based on a universe of more than 2,500 U.S. equity mutual funds with a total of $10.5 trillion in assets, with the S&P 500 used as a benchmark measure.Source: 13F filings, Bloomberg, Barclays“While MFs [mutual funds] are still keeping cash at hand due to attractive short-term yields, their long equity futures positions have also increased to near 2021 levels, indicating a sense of urgency in ratcheting up their exposure to benchmark,” according to the note by Barclays U.S. equity strategist Venu Krishna, along with others. There appears to be a willingness among those funds to “buy into extended valuations that are somewhat justifiable for tech but not for the rest of the S&P.”Tuesday brought another day of advances in equities, leaving the Dow Jones Industrial Average on track for what could be its seventh-straight day of gains and the S&P 500 further above its 15-month high. They managed to shrug off a slightly lower open that followed a tepid retail-sales report for June. So far this year, Dow industrials DJIA, the S&P 500 SPX and the Nasdaq Composite COMP are respectively up by 5.4%, 18.3% and almost 37% — after having experienced a painful performance in 2022, their worst year since 2008.The recent rally in equities is being primarily driven by AI-driven optimism and buttressed by the view that the U.S. economy is able to withstand higher interest rates than previously thought. What makes the rally particularly interesting, though, is that it comes at a time when the rest of the world may be in trouble. On Monday, China reported lower-than-expected second-quarter growth on a year-over-year basis — triggering questions over whether the Asian country and the eurozone, which fell into a technical recession earlier this year, may drag the U.S. down with them. Despite the ongoing risks, “retail [investors’] sentiment has turned very bullish amid enthusiasm for tech, given fading headwinds from rates,” said the Barclays team. “That said, retail demand for equities is still relatively muted compared to bonds or money markets, leaving room for equity inflows to continue into year-end, especially if the 2Q23 [second quarter of 2023] earnings season proves better than expected.”In addition to equity mutual funds, individual investors have also been buying single-stock options, particularly calls or contracts to purchase a certain stock at a particular price up until a defined expiration date. This is among the factors which point to a “grab for upside,” according to Barclays. Meanwhile, global macro hedge funds have turned cautious over the last month, cutting their long-equities exposures they had accumulated earlier in the year. With investors now geared up for a busy week of second-quarter corporate results, hedge funds have “room to add if the upcoming earnings season gives credence to a soft landing scenario.”  As of Tuesday afternoon trading in New York, Dow industrials were up by more than 300 points, or 1%, leading the advance among major stock indexes. Meanwhile, Treasury yields were mostly lower, while the ICE U.S. Dollar Index DXY, which reflects investors’ view on the U.S. outlook versus the rest of the world, waffled between gains and losses before rising by 0.1%

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