INDEX INTELLIGENCE: Fund Investors on a First Quarter Shopping Spree
By Frederic Ruffy, Optionetics.com
5/2/2006 2:45 PM EST
optionetics.com
Mutual fund investors have an important influence on the performance of the stock market. On the one hand, the fund industry today controls trillions of dollars and the buying and selling by portfolio managers will help push stock prices higher and lower from one day to the next. At the same time, the money flowing into and out of mutual funds reflects the decisions and anticipations of millions of individual investors. As a result, these flows also reflect whether investors are predominantly bullish or bearish on the stock market.
Judging by the inflows into stock funds during the first quarter, fund investors are categorically bullish. According to the Investment Company Institute [ICI], fund investors added $34.04 billion to their stock funds during the month of March. That followed $27.33 of inflows during the month of February and $31.58 billion in the month of January. The average monthly flow of more than $30.00 billion is greater than the recent peak seen during the first quarter 2004. Only the first few months of 2000, at the height of the Internet bubble, saw greater inflows than during the first quarter 2006. Investors are adding new money to their stock funds at a fast rate in anticipation of higher stock prices going forward.
The last time mutual funds experienced a month of outflows was in February 2003, which is perhaps one reason the market has been trading rather quietly during the past few years and volatility has fallen back to multi-year lows. Table 1 shows the months with the greatest fund outflows in history. October 1987, August 1998, and September 2001 are all memorable periods characterized by high volatility and rising levels of bearish sentiment. However, there has been no major decline in stock prices for several years and one measure of volatility, the CBOE Volatility Index ($VIX), sits at only 12%--well down from the levels of 30, 40, and even 50% seen in the 2000-2003 period.
Date
Largest Outflows
% of Assets
(in billions)
July-02
-52.63
1.70%
September-01
-29.96
0.89%
March-01
-20.69
0.57%
June-02
-18.05
0.54%
Sept-02
-16.10
0.58%
August-98
-11.58
0.42%
Feb-03
-11.11
0.40%
October-87
-7.48
3.11%
Inflows can also help support higher prices. That is, since stock mutual funds control more than $5 trillion in assets today, money moving in and out of funds is also an important source of liquidity into the market. The money moving in can serve as a powerful force that drives the stock market higher. For that reason, perhaps, stocks are holding up relatively well during the first four months of 2006. Mutual funds purchases are helping to support higher prices. In addition, some might find solace in the fact that $1.7 trillion is currently parked in money market funds, which could also find its way into the stock market in the future.
However, some market watchers might worry that the surge in stock mutual fund purchases this year is yet another sign of excessive bullishness. Just as the hefty mutual fund outflows sometimes indicate that stock fund investors are too bearish, the surge of inflows during the first quarter is perhaps a sign of too much bullishness. That, in turn, can set the stage for possible disappointment going forward.
Meanwhile, ICI also reports that mutual fund liquid assets decreased modestly in March. Fund managers always have some cash immediately available because, if faced with redemptions (outflows when mutual fund shareholders exit the pool), shares must be redeemed for cash. If there is no cash on hand, the fund manager will be forced to sell shares to raise cash. Therefore, the percentage of liquid assets held in mutual funds is important because, if it is low, heavy fund outflows can lead to aggressive stock selling as portfolio managers are forced to liquidate their portfolio’s holdings in order to raise cash.
The chart below shows the percentage of liquid assets held in the average stock fund over the past 18 years. It hit an all-time high in the early-1990s (12.89% in October 1990) and began falling. The percentage of liquid assets held in the average stock fund hit an all-time low of 3.8% in September 2005. The previous low of 4% was set in March 2000. Today, the percentage of cash held in mutual funds is off of the fall 2005 lows, but remains at anemic levels of only 4%.
Figure 1: Mutual Fund Cash Assets (Source ICI)
So, the good news is, money is still flowing into funds and that liquidity is important driver for the stock market. The lack of outflows might also be an important factor keeping volatility at bay. However, the surge in inflows into stock funds (I didn’t even mention the recent proliferation of exchange-traded funds) also reflects levels of bullish sentiment not seen since the market top of 2000. At the same time, the percentage of cash held in stock funds is also at the low levels seen just before the market top of 2000. Taken together, the action seems to be an explosive combination if and when mutual fund investors get spooked and head for the exits en masse.
Frederic Ruffy
Senior Writer & Index Strategist
Optionetics.com ~ Your Options Education Site
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