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Monday, March 22, 2010

Always Watch The Money Flow

I am certainly not one to try to call short tem market moves. On the other hand from readings in behavioral finance, studies that show that investors get returns on their investments far lower than market returns  and from my personal experience with clients and prospects some things are abundantly clear in the world of investing . One of those is  that individual investors) chase the market ,buying at high levels and selling at low levels.

Merely glancing at the chart of the sp 500 etf (spy)  above gives a small picture of this. Note the spikes in volume (bottom scale) during the big moves down starting in the fall of 2008 and the small spike in volume during the recent move up since february of this year. Even those that bought in february missed much of the market recovery and juding by the volume chart most have not yet returned to the equity market. While this is of course a partial view of the equity markets, the mutual fund data described in the article below show the same pattern.

We also know that professional money managers are very concerned with comparative performance  often even more than absolute  performance. For that reason there is a tendency for managers to move to sectors and stocks that have performed well so as not to appear underinvested in the winners and not to have their performance lag the indices. There is also a tendency to rush to invest idle cash that was not invested in equities when the equity market is performing well.

These pattern among both individual and institutional investors are most pronounced at the beginning and end of a quarter or year . For many individual investors year end and/or quarter end  may be the only times of year they look carefully at those brokerage and 401k statements For fund  managers it is the time for scrutiny of their performance in all those quarterly mutual funds reports that can drive cash flows. So flows from cash and bonds to stocks after a period of strong stock performance is very common particularly when investors seem lightly allocated to stocks.

. And it's partially a feedback loop:

The manager cares about relative performance because recent performance drives fund inflows and he is paid based on the growth in funds under management. So he moves money to chase the market winners.

And the individual investor moves money to the  top performing fund in his futile practce of chasing returns. The individual investor will of course be disappointed that past performance wasn't a good predictor of  future performance. Disappointed after a quarter or maybe a year he moves his money to the new hot fund.

That's why I think this wsj article (below) is so interesting it shows this pattern operating in real time.

 I think it is true that the combination of the markets strong performance of late and the fact that fund flows for the past year or so have been into bond not stock funds is significant. It means there is potential for more flows into stocks in the near term a positive for the equity markets. How long that will last and how large that will be I certainly can't tell you.

Can one can generate short term profits based on these anticipated flows ? I'll leave that for others to debate.

from the wsj, my bold my comments in blue

Fuel for Stock Rally: Bond-Market Exodus

First a trickle, then a flood. Investors high-tailed it out of the stock market when the financial crisis hit, pulling some $243 billion out of stock mutual funds in 2008 and 2009, according to the Investment Company Institute.
Their destination: safer havens such as bond and money-market funds. The rush for the exit helped push the Dow Jones Industrial Average down as much as 54% from its peak through the March 2009 low.
Stocks have since staged a dramatic comeback, although many investors are still parked in bonds, haunted by stock losses—a key reason many question how much further the current rally can run.
Now there are signs that investors are growing bolder.
More than $19 billion has flowed into stock funds this year, according to ICI estimates through March 10. This means the soon-to-end first quarter likely will show net inflows into stock funds, compared with a $41 billion outflow in the first quarter of 2009.....
 seems like only a tiny % of the money that went out of stocks funds has returned leaving lots of potential inflows

The pickup comes as investors have slowed their stampede into bond funds. The Dow Jones industrials and the Standard & Poor's 500-stock index have rallied roughly 70% since last March.
And the prospect of ultra-low interest rates for "an extended period," according to the Federal Reserve, also has investors rethinking their exposure to stocks.
no surprise here :
A year ago, "we could have talked blue in the face about the once-in-a-lifetime opportunities" in stocks, but clients "wouldn't even pick up the phone," says Gary Flam, equities portfolio manager at Bel Air Investment Advisors in Los Angeles. Now, Mr. Flam says, clients "are more open to it, they're proactively contacting us asking if it's time to get in."
This in turn may create new momentum for stocks.
Or here:

Of course, investors getting into the market now can't expect the kinds of returns as those who partook in the recent rally. And flows into bond funds are still outpacing those into stock funds.
Any sign, though, that the bond-loving masses may be ready to switch will give bulls another reason to cheer.

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