Logical Assumptions Are Not on the Money

Bull markets can be fueled by many things, including mere sunny optimism about what the future holds. But one ingredient that must ultimately be present is liquidity: You need money to make money in stocks.

So far this year, with the market in the midst of a stunning surge that has baffled many veteran Wall Streeters, individual investors’ voracious appetite for stock mutual funds often is cited as a major force pushing stocks higher.

But, in fact, the net flow of new cash into stock funds between January and May was well below the total in the same period of 1996, according to data from the Investment Company Institute, the funds’ chief trade group.

Stock funds attracted an estimated $92 billion in new money in the first five months of this year, down 26% from the $123.5 billion that flowed in during the first five months of 1996.

Yet the broad Wilshire 5,000 stock index is up about 17% so far this year, versus a 9.2% rise in the same period of 1996.

Less new money, yet higher stock prices? Yes--but that’s partly explained by investors’ focus on a much narrower list of stocks this year. The money that has flowed into the market in 1997 has mostly chased the blue-chip issues that dominate the Wilshire index, while in first-half 1996 the cash inflow was spread among a broader mix of stocks, including many smaller issues.

In any case, if individuals are sending fewer dollars overall to stock funds, a logical assumption might be that money is building up at a fast pace in short-term accounts, such as money market mutual funds and bank accounts.

Logical--but wrong. Through mid-June, taxable money market fund assets are up about $50 billion, or 6.5%, from the start of the year, to $819 billion, according to fund tracker IBC Financial Data.

That isn’t chump change, but it is well below the $61-billion increase in fund assets in the same period of 1996 (a 9.5% rise) and far below the $67.4-billion, 13.5% gain in assets in the same period of 1995, according to IBC Financial.

Similarly, the total in small savings certificates at banks and thrifts has barely risen this year and now stands at $953 billion, data from the Federal Reserve show. Meanwhile, short-term savings deposits (such as bank money market accounts) have actually declined since April, to $1.32 trillion, and the year-to-date gain is lagging the gain in the same period of 1996.

We know that the healthy economy is generating decent income growth for more Americans. So where is their money going? There are, of course, plenty of other investments that might have attracted investors’ cash this year. More people could be buying individual stocks, for example, rather than stock funds. Treasury bills may have siphoned some of the cash that otherwise would have gone into money funds.

But the big winner may simply have been the real economy, as consumers spent aggressively in the first quarter on real estate, cars, clothing, etc.

Has the stock market missed that liquidity? Evidently not. The intriguing question now is whether, with consumer spending apparently slowing, the stage may be set for a resumption of money flows back toward financial assets. If so, that could have very bullish implications for an already hot stock market.

Beating the S&P;: Only a handful of U.S. stock funds have been able to top the Standard & Poor’s 500 index return so far this year. The 10 domestic funds that have beaten the index by the widest margins are listed in the chart. Some of these funds, including American Heritage, Oakmark Select and Sequoia, have shined by concentrating their portfolios in a relative few stocks--a strategy that can cut both ways (a few big losers could slam the funds). Century Shares and Fidelity Select Brokerage are financial sector funds. Rydex Nova, meanwhile, is the ultimate bullish bet: It is basically an S&P; index fund on steroids, using futures contracts to enhance the index’s return.

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S&P; Beaters, So Far

Here are the 10 domestic stock funds that are beating the return on the Standard & Poor’s 500 index by the widest margins in 1997, through last Thursday.

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Total return: Fund 1997 1996 American Heritage +55.4% --5.1% Rydex Nova +28.6 +27.3 Hartford Cap. App. +28.1 NA Transamerica Prem. Eq. +27.0 +29.1 Oakmark Select +25.4 NA Century Shares Trust +25.0 +17.2 Papp America Abroad +24.9 +27.8 Fidelity Sel. Brokerage +24.7 +39.6 Sequoia Fund +24.3 +21.7 MFS Mass. Inv. Growth +24.0 +22.8 Vanguard Index 500 +21.6% +22.9%

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NA -- not available (fund was too new)

Source: Lipper Analytical Services