Friday, January 11, 2013

Suddenly, Everyone Wants to Buy Stocks

Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.
Sir Winston Churchill, Speech in November 1942
Michael Hartnett, chief global strategist at Merrill Lynch, puts out a weekly research piece he calls "The Flow Show".  He tracks the flows into mutual funds and exchange traded funds (ETFs) as a measure of investor sentiment.

For most of last year - indeed, for most of the last 5 years - there has been a steady outflow of investor money from equity mutual funds in favor of bond funds. But now, perhaps, we are seeing some evidence of a change in sentiment.

In his note dated January 10, 2013, Hartnett writes that equity funds saw an inflow of a whopping $22.2 billion last week, which is the second largest inflow ever dating back to 1992.

Even managed domestic equity mutual funds - the bete noire of the industry for the last several years - had inflows of $8.9 billion, making it the fourth largest weekly inflow since 1996.

So does this mean you should barrel into stocks?
Well, no, at least according to Hartnett:
Neither massive inflow nor bullish sentiment guarantees big correction in equities - still need a catalyst; but vulnerability to negative catalyst rising sharply 

5% January dip in January would be healthy; without one risk of much larger correction later in the quarter grows. 

Other signs investor sentiment now bullish: big large specs positions in NKY, SPY, IWM and Oil; 41/45 markets now trading above 200 & 50dma – most bullish reading since Nov'10.
As I have written several times recently, I am inclined to agree with Hartnett. Bullish sentiment seems too wide spread, and investor complacency abounds. A correction of 5% to 10% in such an environment would be consistent with history.

The moment of truth for the markets will come in the next few weeks, in my opinion. Earnings season is upon us, and I suspect that fourth quarter numbers may disappoint bullish analyst expectations.

That said, I would also view any significant correction as a buying opportunity for long term investors.  Stocks relative to virtually any other asset class offers the best risk/reward ratio for the next few years, especially higher quality, dividend-paying stocks in sectors like industrials and health care.