Wednesday, February 6, 2013

Should We Worry About Large Inflows Into Stock Mutual Funds?

Sentiment about stocks apparently turned wildly bullish last month among individual investors.

Equity mutual funds and exchange-traded funds (ETFs) saw the largest inflow of investor cash since February 2000.

A number of commentators have noted the enthusiasm for stocks among investors, and are worried that history is about to repeat itself.  Here's columnist Allan Sloan writing in Fortune magazine:

The way to make money in the stock market is to buy cheap and sell dear. The average mutual fund investor, however, does the opposite: buying at or near market peaks, selling out near bottoms, missing most of the subsequent run-up, then buying again after the market has risen. That sounds elitist, to be sure -- but it happens to be true.

That's the lens through which I'm looking at some fascinating statistics from TrimTabs Investment Research. Last month, TrimTabs says, retail investors put a record $39.3 billion into U.S. mutual funds and exchange traded funds.

The previous one-month record, you'll be glad to know, was $34.6 billion, set in February of 2000. That was at the height of the tech-telecom stock bubble, which began to burst the following month.

It took seven years for the market to regain its 2000 highs. And guess what? That year, 2007, was the last year that investors were net purchasers of U.S. stock funds. That means they bought just in time to get whacked when stock prices began their sickening slide.

I am not convinced, however, that we are in the grips of a euphoric period in stocks.

Yes, investors poured money into the market last month - but they have been net sellers for the past five years. 

Meanwhile, according to ICI data, individual investors also invested nearly $30 billion last month in bond mutual funds. Bonds and cash remain very popular investments among individuals.

Allocation to the public equity markets now stand at 20 year lows, according to Merrill Lynch.  Many institutions were loading up on low yielding bonds over the past several years, and have maintained these positions despite increasing evidence that interest rates are set to gradually rise over the next few years.

In a perverse sense, the more I read that the market is set to correct, the less worried I become.  Yes, I think we are due for a correction - markets never move in one direction all the time - but with so many pension and endowment plans underinvested in stocks I believe the move lower will be relatively short and manageable.

As much as I respect Allan Sloan, comparisons to 2000 and 2007 are not relevant to 2013, in my opinion.

In 2000 stocks had just completed their most remarkable 17 year run in the history of the United States, and valuations were at record highs (the S&P was trading at 44x P/E vs. 14x today).  No one was interested in bonds.

Even in 2007, stocks had just completed a +75% gain since the lows of 2002.  More importantly, even though few knew it, we were on the verge of a massive credit crisis in 2008 brought on by a massive housing bubble.  With central banks around the world in an "easing" mode, credit market conditions seem far different than they were in 2008.

Stocks may not deliver the type of returns we saw in the last 20 years of the century, but they continue to offer the only hope for individuals to save enough for retirement.