As market handicappers continue to anticipate a “Great Rotation” of investor dollars toward equities to purportedly twirl stock indexes still higher, the rotating has largely happened already.
New estimates by firms that follow the money suggest U.S. investors binged on stock funds in 2013 as the big indexes rushed to new highs and bonds suffered their first setback in 14 years. TrimTabs Investment Research calculates $352 billion found its way into equity mutual funds, including exchange-traded funds, last year, nosing ahead of the prior annual record of $324 billion in 2000. Bond funds were the apparent source of a good chunk of that fresh inflow into stock funds, shedding $86 billion.
Some other fund-trackers cite lower net inflow numbers because they count only traditional mutual funds and exclude ETFs – a distortion given the wide popularity of ETFs among investors and financial advisors. Industry trade group Investment Company Institute reported total net inflows into both categories of $318 billion through November, in tune with the TrimTabs estimate.
(Let’s get some of the pesky, inescapable arithmetic out of the way: Money can’t really flow “into” or “out of” stocks in aggregate. For every share of stock a new investor buys, a prior owner has sold it to him or her, in exchange for cash that must then go somewhere – and so on and so on. But retail fund flows do indicate the public’s relative urgency to own, or shun, equities. Higher net inflows usually coincide with growing risk appetites, a willingness to pay higher prices and, conversely, a decreased urgency to sell stocks until and unless prices rise.)
The market’s performance itself – with U.S. stocks outpacing bonds last year by some 35 percentage points, a modern-times record – has also done a lot of the work for investors, lifting their collective exposure to stocks at the expense of everything else.
The December asset-allocation survey by the American Association of Individual Investors reflects this shift. The group’s members said 68.4% of their portfolios were in equities, the highest proportion since June 2007, shortly before the prior stock-market peak. Fixed-income stood at 15.2%, the lowest since May 2009, and cash, at 16.5%, was the lowest since 2010.
Meantime, among many institutions with lots of money to take care of over long spans of time, the equity rally has also been a gift that will relieve them of the need to throw lots of dollars at equities to meet their goals. Corporate pension funds were approaching fully funded status at the close of 2013, for the first time in years. This welcome situation leaves managers looking to preserve their flush condition, which would lead them to taking less risk and locking in better, if still modest, income levels with bonds.
Snapshots of faster-moving traders’ betting ledgers offer a similar view. At the Rydex family of mutual funds catering to market-timers, clients finished 2013 with the highest percentage ever of assets in bullish index funds compared to bear funds, and their allocation to Rydex money-market funds is the lowest since early 2001. Online brokerage TD Ameritrade’s monthly Investor Movement Index of active-trader clients, released Wednesday, registered the highest market-risk exposure in its nearly four-year history. And, as widely discussed on Wall Street, total margin debt in brokerage accounts has reached a new all-time high.
Most of these indicators simply reflect what we already know: Stocks have had a powerful surge since the 2009 bear-market depths which accelerated last year as the economic recovery, household finances and corporate financial health all appeared to improve. Margin debt, for instance, tends simply to track the total value of stocks, so its record-high levels fit with record-high equity indexes. Cheap money and the promise of low rates for a long time have swollen values of all risk assets, from farmland to junk bonds.
Yet this does argue against the popular idea that a wave of investor money is bound to crash onto a parched beach of a stock market. This is no longer – as was popular to argue a year ago – “the most hated bull market in history.”
True, the reallocation toward stocks by public investors has been rather joyless, grudging and in a sense by default, as they judge equities to be the least unattractive choice. While some social-media and green-energy stocks are riding waves of popular enthusiasm to aggressive valuations, on the whole an overlay of skepticism remains toward the economy and stock market – which is a point arguing for the bullish case. Even a shorter "wall of worry" to climb is better than none at all.
"Public euphoria" not required
Still, it’s important not to assume this bull market must necessarily pass through a “public euphoria” phase. Treating the late-‘90s profile as the norm, with typical folks sustaining avid excitement over stock investing for years on end, is likely a mistake, even if equity valuations ultimately are driven to much higher and more dangerous levels. It’s worth recalling that, even as the market topped in 2007 while the credit bust unfolded, some were patiently awaiting the belated return of the Main Street investor. (Trust me, that summer I wrote a cover article for Barron’s headlined “The Missing Man” that asked when the little guy might arrive.)
There’s always a good chance the rediscovery of stocks will continue to gain pace and overshoot in response to a well-supported tape, with dollars continuing to make their way to stock-fund managers. And a bull on the U.S. might also argue the majority of 2013 equity flows went to foreign-stock funds, implying pent-up demand for American shares.
But it could also all be beside the point. Stocks doubled from 2009 to 2012 with the public bailing from stock funds. Too much focus on fund rotation as a reason to expect a good stock market suggests it's a fully priced market in need of a reanimating force to march higher. Maybe so, but it need not be a crowd of latecomers and their cash. Far more will depend on whether companies catch a second wind of earnings growth on quicker global growth – which could well happen – than whether Uncle Tardy elects to shift from bonds to stocks.