A Mutual Fund Selling Panic?

Why it isn't on the horizon

Wall Street's current nightmare is that the huge rush into mutual funds in recent years could suddenly turn into a reverse stampede--bringing the long bull market that began in the early 1980s to a traumatic end. For now, however, economist Martin Barnes of The Bank Credit Analyst is dubious.

To be sure, the flow of cash into domestic stock funds has already abated sharply. With mutual-fund cash reserves at a historically low level, any surge out of funds could trigger a major market sell-off. And the fact that inflows to equity funds in the first half of this year exceeded total household savings doesn't help matters.

But all of that, Barnes believes, simply suggests that a slowdown in fund purchases was more or less inevitable. The real question is whether the current risk profile of households and the psychological and economic factors influencing their investment behavior suggest the possibility of a near-term catastrophic mass liquidation of equity mutual funds. And here the evidence seems reassuring.

For one thing, Barnes oberves that despite the mutual-fund explosion, directly owned equity funds account for only 3 1/2% or so of household financial assets--and a still surprisingly low 5 1/4% when funds held indirectly, via pension plans and trusts, are included.

Other positive omens: Many fund holders are still sitting on sizable gains from recent years and are likely to downplay market turmoil as long as they are ahead of the game. The rapidly rising share of mutual-fund assets in retirement plans--and the aging of the baby boomers--suggests that purchasers increasingly view their holdings as long-term investments. And equity funds experienced only very brief periods of net redemptions during the market corrections of 1987 and 1990.

Barnes concludes that while a further market correction undoubtedly lies ahead, a massive sell-off of equity funds is likely to occur, if at all, only in the wake of a crushing bear market. And the economic developments that could spark such a bear market--such as a severe recession or major inflationary buildup--are still nowhere in sight.

Before it's here, it's on the Bloomberg Terminal.
LEARN MORE