Institutional investors' risk appetite recovered in August from a somewhat subdued level in July, according to the State Street Risk Appetite Index. Demand for risk assets stayed in positive territory for a fifth straight month, extending a solid trend.
Equity allocations in portfolios edged lower but remain close to a 25-year high. The most striking shift in asset allocation was a move out of bonds and into cash, as concerns over inflation, fiscal policy and rising term premiums weakened sentiment toward bonds. At the end of August, equity holdings exceeded bond holdings by 32.5 percentage points, far above the long-term average of 20 percentage points. That was a level last seen just before the 2008 global financial crisis.
The resilience of equity allocations rests on continued strength in corporate earnings. Fund flows, however, have been selective. Toward the end of August, money again concentrated in information technology, while most sectors outside IT saw selling. By region, flows into the U.S. and emerging markets were solid, though within emerging markets they were concentrated in Asia, where technology stocks carry a heavy weighting. Korea and Taiwan, in particular, drew inflows on favorable earnings outlooks. Korean equities also attracted strong buying from institutional investors in August, supported by earnings prospects centered on technology stocks.
Macroeconomic risks are heightening caution toward bonds. Concerns surrounding the Middle East have pushed global energy prices higher again, adding further pressure on price stability. Oil prices are 20% above early July levels, and State Street's PriceStats data likewise show headline inflation pressure building again. Employment indicators also remain solid, raising expectations of interest rate increases, while worries about fiscal policy are putting upward pressure on long-term yields. Rising rates have not yet weighed on equity demand, but the rotation from bonds into cash warrants attention.
In currency markets, preference continued for risk assets, carry strategies and emerging-market currencies. The won strengthened on semiconductor exports, inflows into Korean equities, a solid current account surplus and hawkish messaging from the Bank of Korea. State Street is maintaining a strategic underweight position on the won, given the currency's recent rapid moves and adjustments in currency hedging.
In sum, markets maintained a risk-on stance in August, but money was highly concentrated in technology stocks and artificial intelligence themes. At the same time, investors are trimming exposure to some defensive stocks and traditional duration assets, leaving weak bond flows a point of caution for the time being.
