I like this chart from JP Morgan. As many of you know, I strongly believe that fund flows into and out of equity funds are a huge and often overlooked determinant of stock market returns. In particular, when fund flows go wild after certain sectors, those sectors tend to do well, but when they are in a funk they don’t do so well.
While the chart only goes back ten years, you can clearly see how excess fund inflows coincided with the tech and commodity bull markets while excess outflows coincided with their respective bear markets. This, of course, should be entirely obvious and I may even seem silly to some for pointing it out. So why do I do it? Simply to suggest that all the fundamental and valuation based analysis in the world may mean very little if everyone on the block wants to sell their house but you.
Even more interesting is the fact that it may not take very much in the way of fund flows in or out of the equity markets to make a very big impact on the level of many common stock market indices. For instance, even though the stock market declined nearly 50% from its peak, losing I believe trillions in stock market wealth, only a cumulative $144 billion in equity funds were actually withdrawn over this period of time. While these figures simplify fund outflows by not including entities like hedge funds, it probably still suggests that a large multiplier effect exists for the market when the anxiety and greed associated with fund flows takes over.
As recently as February, fund flows into domestic equities were as depressed as they had been in the last ten years. Not too surprisingly, as the market has gained nearly 40% from the bottoms, fund flows back into equities have also turned positive to the tune of $29 billion.
In the past, periods of excess fund outflows persisted about a year while periods of fund inflows persisted for four years. With fund inflows turning positive in April, let’s all hope the historical pattern remains intact. In the next few days, I hope to share some similar insights from a sector perspective.