Are Foreign Investors Fleeing U.S. Assets?

0:00Welcome to Thoughts on the Market. I'm Serena Tang, Morgan Stanley's chief cross-asset strategist. Today, is the demand for U.S. assets declining? Let's look at the recent trends in global investment flows. It's Wednesday, July 9th at 1 p.m. in New York. The U.S. equity market has reached an all-time high. But at the same time, lingering uncertainty about U.S. trade and tariff policies is forcing global investors to consider the riskiness of U.S. assets. And so the big question we need to ask is, are investors, particularly foreign investors, fleeing U.S. assets? This question comes from recent data around fund flows to global equities.

0:46And we have to acknowledge that demand for U.S. stocks overall has declined, going by high-frequency data. But at the same time, we think this idea is exaggerated. So why is that? As many listeners know, fund flows, which represent the net movement of money into and out of various investment vehicles, like mutual funds and ETFs, are an important gauge of investor sentiment and market trends. So what are fund flows really telling us about investor sentiment towards U.S. equities? It would be nice to get an unequivocal answer, but of course the devil is always in the details. And the problem is that different data sources and frequencies across different market segments don't always lead to the same conclusions.

1:37Weekly data across global equity ETF and mutual funds from Lipper show that international investors were net buyers through most of April and May. But the pace of buying has slowed year-to-date versus 2024. Still, it remains much higher than during the same period in 2021 through 2023. Treasury TIC data point to something similar, a slowdown in foreign demand, but not significant net selling. So where are the flows going, if not to the U.S.? They are going to the rest of the world, but more particularly, Europe. Europe's stocks, in fact, have been the biggest beneficiary of decreasing flows to the U.S.

2:22Nearly$37 billion has gone into Europe-focused equity funds year to date. This is significantly higher than the run rates over the prior five years. What's more notable here is that year-to-date, flows to European-focused ETFs and mutual funds dominated those targeting Japan and emerging markets. This suggests that Europe is now the premier destination for equity fund flows, with very little demand spillovers to other regions' equity markets. These shifts have yet to show up in the allocation data, which tracks how global asset managers invest in stocks regionally. Global equity funds portfolio weights to rest of the world has gone up by roughly the same amount as allocation to the U.S.

3:12has come down. But allocation to the U.S. has actually gone down by roughly the same amount as its share in global equity indices, Which means that if allocation to the U.S. has changed, it's simply because the U.S. is now a smaller part of equity indices. Meanwhile, an estimated$9 billion U.S. dollars from rest of the world went into international equity funds, which exclude U.S. stocks altogether. Granted, it's not a lot, but scaled for fund assets, it's the highest net flows international equities have seen. In other words, some investors are choosing to invest in equities, excluding U.S. altogether.

3:57These trends are unlikely to reverse as long as lingering policy uncertainty dampens demand for U.S.-based assets. But as we've argued in our mid-year outlook, there are very few alternative markets to the U.S. dollar markets right now. U.S. stocks might start to see less marginal flows from foreign investors to the benefit of rest of the world equities, especially Europe. But demand is unlikely to dry up completely over the next 12 months. Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share thoughts on the market with a friend or colleague today.

4:39Serena Tang:The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you.