Tech stocks surrender to financials in incipient rotation to 'QE losers' - BAML

By Helen Reid

LONDON (Reuters) - Flows into equities and bonds this week were undercut by weakness in tech stocks driving heavy redemptions in growth equities, while hopes of U.S. tax reform boosted financials and U.S. small caps.

"Growth" style stocks saw their seventh largest redemptions ever this week as investors dropped fast-growing equities, according to EPFR flows data analysed by Bank of America Merrill Lynch.

Weakness in tech stocks this week took a big chunk out of tech fund inflows, which have been torrential this year.

The Philadelphia semiconductor index sank 8 percent in eight days, while an ETF tracking global internet and e-commerce stocks had its longest losing streak in 13 months as a rotation from highly valued tech stocks into financials gathered pace.

Tech funds saw just $300 million (£222.9 million) of inflows while consumer and financials stocks, seen as benefiting most from potential U.S. tax cuts, drew strong inflows.

U.S. small caps, also a favourite play for investors looking to cash in on a lower corporate tax rate, drew in $0.6 billion.

Defensive utilities, healthcare and real estate all suffered outflows as progress on U.S. tax reform re-ignited investor preference for cyclical shares.

Meanwhile, the smallest investment-grade bond inflows in 50 weeks and sixth consecutive week of high-yield outflows also indicated investors' hunger for yield was fading.

Both patterns in fixed income and equities hinted at the beginnings of a rotation from "QE winners" to "QE losers", BAML strategists said.

The leadership of growth stocks and higher-yielding fixed income assets would end as quantitative easing was phased out, fiscal stimulus started and rising inflation caused higher bond yields, they said. The missing piece so far is inflation, they said, which has remained stubbornly low in the United States.

Accordingly, wage data from the U.S would be critical for the path of the market ahead, the U.S. bank said, eyeing the release of November non-farm payrolls later on Friday.

"U.S. tax reform needs wage growth to cause higher yields and sustained rotation to QE-losers," BAML strategists said.

The regional breakdown showed continued strength for the United States, drawing inflows of $1.7 billion, and Japan with $1.3 billion, while Europe and emerging markets suffered small outflows.

FLOWS POINT TO A PEAK

Record inflows into bonds and stocks this year ($347 billion and $286 billion respectively) could herald poorer returns around the corner, BAML strategists said.

Past years of strong equity inflows in 2010, 2013 and 2014 were followed by poor returns, especially when the bank's bull & bear indicator of market exuberance was high.

Risk assets could still see significant further gains this quarter and the first quarter of 2018, but "both credit and stocks peak early 2018," they predicted.

Strategists have pushed their forecast for a market peak later and later this year as stocks rose relentlessly.

(Reporting by Helen Reid, editing by Larry King)