By Helen Reid
LONDON (Reuters) - Equity funds suffered their second-largest weekly outflows ever this week, with $29.7 billion pulled out of risky assets, Bank of America Merrill Lynch (NYSE:BAC) (BAML) strategists said on Friday as fears about rising U.S. protectionism continue to weigh.
U.S. equity funds lost $24.2 billion in their third-largest ever weekly outflows, EPFR data cited by BAML showed, as markets sealed a first half marked by higher volatility, rising U.S. interest rates and increasing global protectionism.
The outflows from U.S. equities were in marked contrast to last week, when the United States was the only developed equity region to draw inflows.
Outflows from emerging market (EM) equity and debt funds also accelerated as investors shed EM assets, betting on a hit to emerging economies from a sharp rise in the U.S. dollar.
Some $18 billion coursed out of EM equity and debt funds in June after an $8 billion outflow in May.
European stocks suffered their 16th straight week of outflows with $3.9 billion pulled out of the region's funds, while Japan saw $2.6 billion of inflows.
Among equity sectors, technology has been the most resilient to trade worries, although threats to curb Chinese investment in U.S. tech this week hit the stocks.
Tech continued to draw the strongest inflows, however, with $0.8 billion, and was on a year-to-date total of $19 billion inflows while $9 billion has left all other sector funds.
CONTRARIAN BUYING AHEAD?
In fixed income, investment-grade bond funds saw strong inflows of $2.9 billion as investors fled to safety, while high-yield bond funds saw outflows for an eighth consecutive week, with $2 billion removed.
High-yield bond funds were on track for a record $90 billion of outflows this year, a consequence of the changing global interest rate environment thrusting core yields higher.
BAML's private client allocations showed U.S. government bond holdings surged to a 10-year high, but positioning on risky assets remained positive with cash allocations at a record low of 9.9 percent and equities at 61.1 percent.
The bank's "Bull and Bear" indicator of investors' appetite for risk dropped to 2.4, nearing levels the strategists see as a cue for contrarian buying.
Triggers for the gauge to fall to 2, the "buy" signal, could include the S&P 500 falling below 2,665 points and another two weeks of EM and high-yield outflows.
"Buy 'humiliation' in distressed EM and EU when triggered," BAML strategists wrote.
"ECHOES OF 20 YEARS AGO"
The BAML strategy team drew comparisons between the current market environment and the Asian financial crisis of 1997-1998 that triggered the bailout of hedge fund Long-Term Capital Management.
"Fed tightening, U.S. decoupling, flattening yield curve, collapsing EM, outperforming levered quant funds... all echoes of 20 years ago," they wrote, detailing areas to watch for signs a 1998 scenario could unfold again.
"Oil, banks, yield curve are our favorite summer 'tells' for 1998 redux."
Further pressure on the Chinese yuan, which already suffered its worst month ever in June, could also be a trigger as well as an unwind of "crowded" positions such as long U.S. tech and long U.S. dollar, the strategists said.
Interest rate insensitivity, or a failure from central banks to revive risk assets with artificially low bond yields, would also be a danger sign for them, and they pointed to bank stocks as harbingers of this.
Financials stocks suffered $1.1 billion of outflows this week.
