Buyers Or Sellers?

12/10/2012


Many bullish investors point to steady outflows from equity mutual funds as a reason to be positive on stocks. They hold that significant market tops rarely occur when investors are overtly bearish, and net outflows in equity mutual funds in 17 of the last 18 months suggest individual investors are hardly euphoric about stocks.

Yet, when you dig a bit deeper, it's tough to argue that investors are dumping stocks en masse.

Investors are selling equity mutual funds but buying exchange-traded funds. According to the Investment Company Institute, net inflows into equity ETFs were $71.5 billion in 2011 and $43.5 billion through the first half of this year. These inflows offset much of the net outflows from equity mutual funds of $128 billion and $31 billion over the same time periods. And for the four-year period ending June 30, net inflows of $416 billion to equity ETFs more than offset the net $388 billion in outflows from equity mutual funds.

Retirement accounts provide another slant. According to the Investment Company Institute, U.S. and foreign stocks made up 57% of the mutual-fund retirement assets (IRAs and defined-contribution plans) at the end of 2008. Hybrid funds holding both stocks and bonds accounted for 17% of retirement assets. Now, fast forward to the end of 2011. Retirement plans had 54% in stocks and 21% in hybrid funds.

Thus, the percentage of equity in retirement accounts (factoring in both stocks and hybrid funds) remained fairly consistent from 2008 to 2011.

The data raise an important question. Are investors aggressively selling stocks? Or are they simply moving from active equity strategies to more passive approaches involving ETFs that track indexes? A shift toward passive investing would signal more pessimism about active strategies, but not necessarily about stocks.

A rise in the popularity of passive investing might explain why many market watchers view today's investors as complacent. The Chicago Board Options Exchange Volatility Index, otherwise known as the VIX, measures expected volatility for the S&P 500 Index as implied by option prices. Also known as the "fear gauge," the VIX stands at 16, well below the average of nearly 21 since the start of 1990. With the fear gauge running at such modest levels despite plenty of reasons to be nervous — the fiscal cliff, continued problems in Europe, and Middle East unrest — some sentiment watchers believe investors are too complacent, suggesting the market is headed for a tumble.

But does this bearish argument hold up if investors aren't complacent, but instead more comfortable with an investment approach that demands less action? Are complacency and passivity two sides of the same coin?

Based on data reviewed above, we believe the question of whether investors are buying or selling stocks may not be the most telling in evaluating investor sentiment. Individual investors' comfort level with stocks has apparently remained relatively consistent.

A better question is whether investors' preference for passive rather than active investment can affect stock-market performance. If the pendulum continues to swing toward passive investing, indexes should benefit, making it more difficult for active managers to beat benchmarks, at least in the near term. However, this argument has a flip side: The shift toward passive investing has been quite strong for the last four years. History teaches that when an investment approach captures investor dollars at such a rapid rate, that approach may be nearing the end of its winning streak.

Bottom line: The Forecasts continues to believe that both passive and active equity investing can coexist in the same portfolio. Investors should not ignore the opportunities available in individual stocks, especially those on the Forecasts buy lists.


Current Hotline

Stock Spotlight

Individual Stock Reports

ISRs make stock research easy!

Perhaps the most valuable two page reports available anywhere.

All the data you would normally have to plow through years of 10-K filings, earnings reports, and reams of market data to assemble — yours all in one concise report.

ISRs contain our proprietary Quadrix scores — find out how we rate all the stocks in the S&P 500.

Visit us at individualstockreports.com