The ‘most aggressive’ areas of the stock market could be set for more gains as spiking bond yields shuffle portfolios, a Wall Street chief strategist says

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  • The reversal of a multi-year trend could have been accelerated this month as interest rates spiked higher, according to a note from Leuthold Group’s James Paulsen.
  • Investor fund flows have started to favor stocks over bonds, which hasn’t happened in years.
  • “When fund flows have shifted toward stocks, it has typically led to leadership from the market’s ‘most aggressive’ sectors,” Paulsen said.
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Rising interest rates sparked a volatile week of trading for the stock market, but it could also be accelerating the reversal of a multi-year trend that suggests more long-term upside ahead for stocks, according to Leuthold Group’s James Paulsen.

As interest rates rise, bond prices fall, which often sparks current fixed income investors to question whether they own too much of the asset class and not enough stocks, Paulsen said in a note on Thursday.

And there are likely a lot of investors asking that question right now, given that over the past decade, fund flows have overwhelmingly favored bonds over stocks. Even since the start of 2019, bonds have seen cumulative fund inflows of more than $1 trillion, while stocks have seen cumulative outflows of about $600 billion. 

And according to Fundstrat’s Tom Lee, 94% of retail fund flows have gone into bonds rather than stocks since 2008.

But more recently, this trend has reversed, with stocks seeing an uptick in inflows at the expense of bonds.

“This newfound trend of investment flows probably has a long way to go,” Paulsen said, and if so, the stock market should find strong support from the new money pouring into equities.

Sectors that have led the market higher during a sustained trend of fund flows into equities are the “most aggressive,” according to Paulsen.

If cumulative fund flows into stocks turn positive, “not only could the stock market continue to surprise to the upside,” but the most aggressive sectors might keep leading the market higher, Paulsen concluded. 

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