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Fund Inflows at Bubble Levels April 29, 2006
Over the past three months, investors have stormed back into stock mutual funds.
While flows into international funds have garnered a lot of attention lately (and rightly so), it's not like U.S. funds are standing at the street corner with their hats in their hands - they're getting plenty of attention themselves.
The chart below speaks loudly to the type of rush we've been seeing:
Over the past quarter, stock funds have seen an average monthly inflow of over $30 billion - that's higher than the previous peak in February and March 2004. In fact, it's higher than all previous peaks except for the biggest one of them all at the height of the bubble in the spring of 2000.
On the bright side (?), there is a potential reserve of $1.7 trillion sitting in taxable money market funds. One could say that that's a significant pool of money that could find its way into stock funds, potentially driving prices higher.
But take a look at the chart below, which shows the amount of assets in money market funds as a percent of the assets in stock funds:
As of the latest data available (through March), money markets had less than 1/3 of the assets that stock funds did. This is the lowest ratio in the past 20 years. January and February of this year had the next two lowest ratios, then we'd have to go back to August 2000 - the very top of the bubble - for the fourth-lowest reading.
Now for the most disturbing part of all...
Investors are showing this kind of preference for stocks despite rising "risk-free" yields available from the money market funds. Instead of stashing money in a money market account where they can get an almost-guaranteed yield of 4.0% - 4.5% or even higher, they are helping companies like E-Trade post daily trade numbers more than twice as high as last year.
But we've seen this story before. Three times, in fact. Three times when short-term rates jumped higher, but the amount of assets in money markets as a percent of total stock assets drove to new lows.
Two of them lead to a market crash, the third to a 6% correction. Those three precedents were September 1987, August 1994 and August 2000.
It isn't just regular investors who are holding low percentages of cash - professional fund managers are as well. Check out the Mutual Fund Cash Surplus / Deficit that we post to the site. This takes the percentage of assets that fund managers are holding in cash and adjusts it for the level of short-term interest rates (since rates are a main driver of how much cash fund managers decide to hold).
According to this calculation, managers are holding 4.0% of their assets in cash when they should be holding 6.8%. This 2.8% deficit is one of the largest in history. Going back 50 years, any other month that showed this large of a deficit had an average one-year forward return of -11% with only 1 out of the 14 instances being positive.
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