Exodus From Stock Funds Continues

Stock mutual funds are facing net outflows of cash for the first time since September, as small investors step up their selling amid Wall Street’s steep decline.

But that throw-in-the-towel mentality among fund investors in the past has signaled that the market was reaching at least a short-term bottom, analysts say.

Hopes for a timeout in the bear market were bolstered Thursday, as key indexes recovered from sharp losses to close mostly higher. The Nasdaq composite finished with a gain of 28.42 points, or 2.1%, at 1,374.43, and the Dow industrials pulled up from a 208-point loss to end at 8,801.53, off 11.97 points.

Stock mutual funds have been a major source of support for the market since the early 1990s: Nearly every month in the last decade the funds have taken in more cash from new fund purchases than has left from investor redemptions.

In June, however, stock funds suffered net withdrawals for the first time since September, according to estimates, and analysts say outflows have persisted this month as people have shifted cash toward fixed-income investments, real estate and other options.

According to AMG Data Services of Arcata, Calif., domestic stock funds have seen six straight weeks of net outflows, a longer streak than the exodus that occurred before and after the Sept. 11 terrorist attacks.

“Investors have been through a lot of pain and for a long time now,” said Don Cassidy, senior research analyst at fund tracker Lipper Inc. in Denver. “A lot of them are saying, ‘I don’t care at what price--just get me out of the market, and I’ll never buy another stock again.’ ”

But “contrarian” analysts view that attitude as potentially bullish, because it may indicate that the selling is reaching a peak, setting the stage for the market to bottom.

Net stock fund redemptions in March 2001 and in September preceded rallies, Cassidy said.

So far in July, a net $17 billion has been pulled from stock funds, compared with net redemptions of $20.9 billion for all of June, according to estimates by TrimTabs Investment Research of Santa Rosa, Calif.

“This is panic selling,” said Charles Biderman, TrimTabs’ president. “We are in the bottoming process, but it could take awhile.”

Analysts hesitate to guess how long the bottoming process might take--or how much heavier fund redemptions could become before sellers have exhausted themselves.

The $30-billion outflow in September culminated three straight months of net withdrawals. Also, investors were net sellers of stock funds for 16 of 18 months after the 1987 market crash.

“The nature of [investors’] discontent appears to be wide open,” Cassidy said. “Can anyone say we’ve seen the final terrorist strike or the final corporate scandal?”

Investor selling so far has been focused on domestic stock funds, while foreign stock funds, which generally have performed better this year and could benefit from continuing weakness in the dollar, have held their ground.

Analysts say fund investors are losing faith in U.S. accounting and corporate governance standards, given the explosion of financial scandals. There also may be anxiety over how legislative anti-fraud efforts in Congress could affect corporate operations.

“A wise person once said that no man’s property is safe while the legislature is in session,” Biderman said.

Thus far, redemptions have been moderate and manageable, fund companies say.

At San Francisco-based Charles Schwab Corp.’s mutual fund supermarket, a net $192 million was yanked from stock funds last month, compared with $1.6 billion in September.

At Vanguard Group in Valley Forge, Pa., spokesman Brian Mattes called June’s $105-million net outflow “a trickle” compared with $1.3 billion that left in September.

Although redemptions and exchanges have been light, more people are directing new cash toward fixed-income funds, Mattes said: Vanguard’s bond funds took in a net $2.9 billion in June, their best-selling month of the year.

Stock mutual funds hold about $3.3 trillion in assets, about one-fifth of the market, according to the Investment Company Institute, the industry’s main trade group. Though the funds don’t dominate the market, if fund managers are forced to sell stocks because of investor redemptions, it can add to downward pressure on prices.

Many stock funds hold a cash “cushion” to tap in the event of redemptions. But that cushion has grown thinner since the early 1990s. Cash holdings in stock funds totaled 5.1% of assets at the end of May, compared with levels of 10% or more in 1989 and 1990.

Some investors say fund redemptions are particularly hurting stocks in the out-of-favor large-cap growth segment of the market, where the biggest outflows have come.

The market’s decline this week has been led by blue-chip shares, including drug stocks that are favorites of many growth mutual funds.