What Fund Flows May Be Saying
By Sam Stovall
The total market value of the S&P 500 on March 31, 2000, was $12.7 trillion. As of March 27, 2003, it had fallen to $8 trillion. Ouch. No wonder equity mutual funds have suffered a similar fate, seeing their asset values tumble from $4.4 trillion on March 31, 2000, to $2.5 trillion as of February 28, 2003 (based on the latest available data from Investment Company Institute, released Mar. 27).
Bond funds, however, have expanded their assets under management during this period to $1.2 trillion from $793 million as investors sought yields and safety. Money-market assets have also ballooned to $2.2 trillion from $1.7 trillion, for similar safety and yield reasons.
Source: Investment Company Institute
Does the slide in stock-fund assets accurately reflect equity-fund shareholders' dissatisfaction with that category since the beginning of the bear market? Not really, since the decline includes both the effects of fund flows -- the net effect of fund shares newly purchased and existing shares redeemed -- and the bursting of the equity market bubble.
In my opinion, it would be more appropriate to review just the amount of money that has flowed into and out of equity funds since the beginning of the bear market. So here's a quiz: After nearly three years, what kind of flows do you think equity funds saw from the market's top through the end of February, 2003:
A. Outflows of $100 billion
B. Outflows of $200 billion
C. Outflows of $300 billion
D. None of the above
The answer, believe it or not, is "D." Bear-bitten investors could be forgiven for guessing "C." And they would've been right about the magnitude of the move -- but wrong about the direction.
With the help of Rosanne Pane, director and mutual-fund strategist at S&P, I looked into fund flows over the last three years. Not surprisingly, from March, 2000, through February, 2003, investors added more than $438 billion to money-market funds and more than $211 billion to bond funds in search of increased safety and yields from the end of the bull market until early this year. But I was very surprised to find that during this same period investors added nearly $304 billion to equity funds.
Yes, added. In fact, equity funds experienced a relatively steady stream of net inflows until June, 2002. Since then, however, investors appear to have some second thoughts and have pulled out more than $110 billion. What does that change of heart signal for the market? Are equity fund flows a leading, lagging, or coincident indicator?
Take a look at the chart above, which compares the S&P 500 with a rolling 12-month sum of all equity-fund flows since 1984. I chose to plot the rolling 12-month value, since a chart of monthly flows would have been too jagged. And while fund-flow data back to the 1960s would have been preferable, ICI offers stock-flow data only back to 1984.
The chart seems to indicate that equity fund flows are at best a coincident indicator and are more likely a lagging indicator, since investors appear to get sufficiently discouraged to pull money out of equity funds only when the worst is just about over. This pattern can be seen by the outflows in 1987-88, after the 1987 crash; in 1995, after multiple interest rate increases during 1994-95 caused stock prices to decline; and in 1998-99, after the dramatic market decline in the 1998 third quarter in the wake of the demise of hedge fund Long Term Capital Management.
And what about today? Now that investors are withdrawing money from equity funds at a rate not seen in decades, does that mean the bear market is over? Possibly. From a contrarian standpoint, the phenomenon at least offers additional reason to say the market is approaching a bottom. It gives S&P more cause to believe that once investors' focus turns away from Iraq and back to the favorable fundamentals offered by the prospects of an improving economy and rebounding earnings, that equity prices will slowly work their way higher, giving earnings time to catch up with valuations.
But until that happens, S&P suggests that investors take advantage of attractively valued 5-STARS stocks found in the economically sensitive areas of the market and not overreact to inflammatory headlines.
Stovall is chief investment strategist for Standard & Poor's