Cash flows reverse and money finally starts to go back into stock mutual funds

11/04/2010 12:45 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com



Does this make you nervous or confident?

Individual investors have finally decided to stop withdrawing money from equity mutual funds in order to buy bond mutual funds. Since the start of September $13.3 billion has flowed into U.S stock funds and $1.2 billion back into European stock funds, according to EPFR. According to the Investment Company Institute, which tracks flows in a different manner, net cash flows turned positive for U.S. equity mutual funds in the last two weeks for the first time in six months.

This still leaves the flows for the year very heavily into bond funds and out of stock funds. For the year, according to EPFR, about $50 billion has left U.S. equity funds and $20 billion has flowed out of European equity funds.

I guess individual investors are finally convinced that stocks are a better bet than bonds. All it’s taken is for the Federal Reserve to drive interest rates down to 0.11% on the 3-month Treasury bill and to 2.62% on the 10-year Treasury bond, and for the Standard & Poor’s stock index to rally by 14% from August 26 to 10:30 ET on November 1.

If you know the reputation of individual investors as a group that buys into a trend near its top, this move towards stock mutual funds quite possibly make you nervous. Isn’t this a sign that this rally is about to fold like a venetian blind?

I’d say certainly not yet for two reasons.

First, the trend out of stock funds and into bond funds has a way to go before we reach break even on the year. Sure, investors put $13.3 billion into U.S. stock funds in September, but considering the $50 billion that has left these funds in 2010, cash flows need to continue for a while before equity funds hit break even—let alone show a cash flow bubble for the year.

Second, the Federal Reserve has just promised to keep trying to drive bond rates lower for the rest of 2010 and into 2011. That's the goal of the Fed' $600 billion program of Treasury buying announced on November 3. That would keep alive one factor that has pushed money out of bonds and into stocks in recent weeks.

In other words, I don’t think that the stock market is about to reverse on a dime just because mutual fund investors have rediscovered stocks.

The key to the market remains the Federal Reserve. You can say that mutual fund investors have now latched onto that fact.

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