This Number Shows the Stock Market’s Selloff Might Not Be Over

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Money moving away from credit means that investors have weakening confidence in consumers’ and companies’ ability to repay their debts.

NYSE

Stock traders may not have fully “capitulated” yet, which means there could be more selling to come. One indicator: declining interest in the credit market. 

Capitulation is when investors lose all confidence in the outlook for stocks prices, even after they have tumbled. That usually coincides with a deteriorating outlook for economic growth and corporate earnings.

The capitulation stage of a market sell-off is key because it often signals the end of the declines, as investor sentiment can’t get much worse from that point.

This is especially important now, with the S&P 500 down 21% from its January all-time high, as inflation has prompted the Federal Reserve to increase interest rates in order to cool down economic demand.  

Those market declines could worsen from here, as stock investors just may not have fully thrown up their arms—or capitulated—yet.

The cumulative net inflow to equity funds since the start of 2020 has risen to almost $1.4 trillion from just over $1.2 trillion weeks ago, according to Bank of America data. That means money has flowed into stock funds in those weeks.

That’s consistent with heavy dip-buying in stocks seen on Tuesday.

The belief is that, with stock prices down so much and the economic outlook having already worsened, maybe it’s time for fund managers to begin buying a few shares of companies they are confident in. Maybe the market outlook is improving—a little bit. 

But that’s not what the credit market has been saying. The cumulative net inflow to credit funds—those that buy and sell corporate and household bonds—since early 2020 has fallen to about $900 billion from about $1.1 trillion weeks ago.

This means investors have been redeeming their share in those bond funds recently. Money moving away from credit means that investors have weakening confidence in consumers’ and companies’ ability to repay their debts, as the outlook for household income and corporate earnings dims. 

“Capitulation has been in credit,” wrote Michael Hartnett, chief investment strategist at Bank of America. “[That’s] why we worry equity lows not yet in.” 

The idea is that because there is added risk to corporate earnings, stock investors could be the next group of financial market investors to pull money from funds.

Indeed, flows into stock funds are high correlated with flows into credit funds, historically. So the divergence in the last few months—flows out of credit but into stocks—can’t hold up for much longer.

If money once again starts flowing out of stock funds, it would force equity fund managers to sell some stock, and would also be reflective of an environment in which other types of stock market participants are selling, too. 

Sometimes the stock market just needs to take a hint from the bond market—and it may do that soon. 

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com