Opinion: Watching investment flows identifies trends, dangers

Richard Baker

Monitoring the flow of the wet weather creek at our old house was important if we didn’t want to replace our road. The creek was usually dry, but heavy rain could make it rise 10 to 12 feet in minutes, overwhelming our three-foot culvert.

I continually watched it, ready to act if the pipe got clogged and threatened our road. Similarly, I continually watch investment flows to look for trends or dangers.

Investment fund flows, which measure the movement of cash in and out of investments, can reveal patterns in investor sentiment and general investing trends. Reviewing the July fund flow activity, I noticed a trend: Investors like the top and bottom of the market but are shying away from the middle.

The Morningstar category data for July showed that the financial sector had the most inflow, gaining $3 billion in July alone. This continued a trend we’ve seen all year, highlighting investors who may be chasing performance in anticipation of a Federal Reserve rate cut.

The technology sector received the most inflow after financials. Technology gained over $2 billion in July as investors continue to see earnings opportunities in artificial intelligence and cloud computing. Technology has outpaced all other sectors by a significant margin year to date. Utilities, industrials and energy are the only other sectors with positive inflows in July.

Investors seem to be hedging their bets on a Fed rate cut and a continued market surge. They will watch Fed Chair Jerome Powell's speech on Aug. 23 for clues about the Fed's next moves.

Where was the money moved from? Mostly from communications and health care, which had the most outflows. The communications sector lost $687 million, and the health care sector continued its draining trend by losing $259 million in July and over $10 billion this year to date as the Medicare reimbursements drama continues to weigh it down. Next on the list of losing sectors were consumer staples, real estate and consumer cyclical, which had negative outflows for July, and all have negative outflows year to date.

Despite July's overall strong market performance, investors continued to move toward the top and bottom ends of the market capitalization (total value). Stocks categorized as large blend and small blend had the largest inflow of new investment, while stocks in the middle, categorized as mid-cap growth and mid-cap value, had some of the biggest investment outflows. Mid-cap growth stocks have lost over $20 billion this year, more than any other category.

So, what should investors do? I am resisting the urge to overweight financials despite July's strong performance and the potential for possible deregulation under a Donald Trump victory scenario. I am staying neutral with financials because of my concerns with regional bank exposure to commercial real estate.

I continue to be overweight to communications even though it was the top sector for outflows. There have been some earnings misses here, but I believe the contentious elections will give the communications sector an earnings bump with their huge political advertisement spending.

Often, debris from flash floods would clog our pipe with limbs and leaves. I kept a 20-foot pole with a big hook nearby for this type of emergency. Similarly, a good investment professional should be watching the market with a big hook on the ready to maneuver their accounts away from danger before it happens.

Richard Baker, an accredited investment fiduciary, is the founder and executive wealth adviser at Fervent Wealth Management LLC in Springfield. He can be reached at richard@ferventwm.com.