Stock Fund ‘Mania’: Not What It Seems

The stock market goes ever higher, and individual investors--specifically, individual investors in mutual funds--invariably get the credit, or the blame, depending on your viewpoint.

“It’s a mutual fund mania!” Wall Street likes to say.

Really? Let’s look at the numbers:

* The Standard & Poor’s 500-stock index is up 28.6% year-to-date.

* In the first six months of this year, the net cash inflow into stock mutual funds was down 20% from the same period of 1996, to $110.2 billion versus $138.1 billion a year earlier.

* Also in the first half of this year, the net new cash flow into money market mutual funds jumped 60% from the first half of 1996, to $43.2 billion.

So for every new $1 investors put into stock funds in the first half, they also put 40 cents into super-safe, low-yielding money market funds.

Hmmmmm. What’s wrong with this picture? The stock market certainly looks maniacal. But can individual investors still be “maniacs” if they’ve actually cut back the pace of their stock fund purchases, and boosted the flow of cash into safe, short-term accounts?

Mutual fund money flows have come to be viewed as crucial to the stock market’s trend for two main reasons. First, they measure the sentiment of small investors, who in fact own the majority of stock out there (either via individual shares or through funds).

Perhaps just as important, however, is the simple fact that the fund numbers are available on a monthly basis, neatly calculated, packaged and reported by the Investment Company Institute, the funds’ chief trade group.

In other words, they’re an easy set of numbers to get and digest. Hence, they’re widely reported in the media.

But are fund flows the all-important determinants of whether stock prices are headed higher or lower? Evidently not, if we just consider this year’s results: stock prices way up, stock fund inflows down. The data beg a little more explanation. Here goes:

Have investors lost their appetite for stock funds this year? Not really. While the media focus usually is on “net new cash flow” into the funds, that figure is derived from a bigger number: gross purchases, which is the total dollar amount of money used to buy fund shares, either through retirement savings plans or by individuals writing checks directly to fund companies.

The gross purchase total for stock funds was $277.1 billion in the first half of this year, up 18% from the $235.4 billion total in the same period of 1996, according to the ICI. So investors have been bigger buyers of stock funds this year, overall.

But just as buying is always going on, some people also are selling fund shares, for whatever personal reasons they may have.

That’s where the surprise has been this year: Stock fund redemptions soared 50% in the first half, to $170.5 billion from $113.3 billion in the same period of 1996.

Moreover, there’s another method of cashing out of a fund: exchanging the shares for shares in another fund in the same company (say, Fidelity or Vanguard). Exchanges into stock funds (such as from money market funds) have been positive this year, but much less so than last year: a net $3.7 billion, down from $16 billion in the first half of 1996.

The bottom line: Subtract the redemptions from gross fund purchases, add in the net exchanges, and you get net new cash flow--the net amount of dollars stock fund managers have received this year from investors.

If you look only at the gross purchase number, you could argue that many stock fund investors still are very bullish and are showing no fear--a mania! But the redemption and exchanges data paint a picture of a large subgroup of fund investors who feel very different. They have been pulling money out of stock funds this year, enough so that the net amount of dollars flowing into fund managers’ pockets has been reduced 20% from 1996’s record levels.

Yet, given the continuing rise in share prices this year, it’s clear that whatever net cooling of stock fund demand has occurred, the market hasn’t missed it terribly. So cash must be coming from somewhere else.

In other words, if it’s a mania we have on Wall Street, perhaps we ought to be wagging a finger or two in the direction of some other group besides the individual American fund investor.

*

Stock fund managers, for example, may be looking a lot more maniacal, at least relative to their shareholders’ collective caution.

For the average stock fund, the percentage of assets held in cash as of June 30 was 5.8%, the ICI said, down from 6.1% in May and near the lowest levels seen in 21 years. If you want to post decent returns in a hot bull market, you can’t be sitting there with a cash cushion on your fund balance sheet. You’ve got to put that money to work in stocks--the heck with waiting!

And how about foreign investors? The strong dollar makes it doubly advantageous for a foreigner to own rising U.S. financial assets, after all. If they aren’t buying U.S. stocks, they should be.

Meanwhile, there is the corporate investor. Liquidity Trim Tabs, a market newsletter based in Santa Rosa, Calif., estimates that newly announced corporate takeovers in which cash, rather than the buyer’s shares, are offered for the target’s stock have totaled $34 billion in the last two months alone, while averaging $10 billion in the first seven months of 1997.

“If this new higher level of [cash] takeover activity is sustained, then this market will go even further to the upside,” the newsletter suggests.

All in all, there clearly is a lot of buying in this bull market that can’t be attributed to the fund investor’s marginal dollar. Fund tracker Morningstar Inc. recently summed it up this way, in a report titled “Spare the Usual Suspects”: As big as stock fund cash inflows may appear, Morningstar said, domestic-fund inflows would have accounted for less than 5% of total dollars traded last year on the New York Stock Exchange, even assuming that every last new fund dollar went into stocks.

“Funds may contribute to the trend,” Morningstar concluded, “but they aren’t driving this market.”

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Two Sides to Fund Flows

Gross stock fund purchases have risen this year, but redemptions of fund shares have risen much faster, in percentage terms. Purchases versun redemptions, in billions of dollars, first-half 1997 and first-half 1996:

Purchases

1996: $235.4

1997: 277.1

Redemptions

1996: 113.3

1997: 170.5

Source: Investment Company Institute