Follow The Money


Pinning down investor sentiment is akin to nailing Jell-o to a tree. It ain't easy.

For example, the current reading of the American Association of Individual Investors (AAII) Sentiment Survey, often used as a proxy for individual investor sentiment, shows a split decision in the battle between the bulls and bears. About 29% are bullish, 31% bearish, and the remainder neutral. Compare those numbers to the latest reading from the closely watched Investors Intelligence Advisors Sentiment Survey, which shows bullish advisors tracking at nearly 53%, versus 23% for bearish advisors. 

Two sentiment indicators, two different readings on the market. And therein lies a problem with sentiment indicators — we can usually find a reading to support any position on the market.

Don't dwell on absolute sentiment numbers; context and trends matter more. In addition, sentiment indicators that rely on investors' words have limitations, which explains why we also look at sentiment indicators based on investors' actions — like flow of funds.

What investors do with their money may be the best indicator of their thoughts about the market. When looking at fund flows, always do these three things:

Include exchange-traded funds (ETFs) in your analysis. Some fund-flow data looks only at open-end mutual funds. However, ETFs are grabbing a growing share of investor dollars, and a healthy chunk of that cash comes from open-end funds. Data that ignore ETFs could tell a misleading story.

Get granular on the data to create a mosaic of fund flows. There is value in knowing a simple binary result — for example, U.S. equities are seeing net outflows while U.S. bond funds attract new money. But you may come to more nuanced conclusions if you use detailed flow numbers. For example, would you think differently about investor sentiment if you knew that small-cap and midcap funds were hemorrhaging cash but large-cap funds were seeing net inflows? Would you view the bond-fund market differently if money was pouring out of Treasury funds, while riskier high-yield funds showed inflows?

Use this data to broaden your perspective, not do microsurgery. Sentiment indicators, including fund flows, can enhance your view of the market. However, the numbers lack the laser precision necessary to rely on them to drive investment decisions. 

So what are investors doing with their money? Broadly speaking, they are selling stocks and buying bonds. Through July of this year, net outflows for U.S. equities, including sector funds, totaled $66 billion. Among the nine major size classifications, only large-cap blend, large-cap value, and small-cap value funds showed net inflows. As a group, international equities registered modest net inflows of $7.7 billion through July. Conversely, taxable and municipal bond funds saw net inflows of nearly $163 billion. Investors seemed willing to assume risk on the bond side, with high-yield corporate bonds seeing net inflows of more than $12 billion, high-yield munis $9.1 billion, and emerging-market bonds $5.4 billion.

Fund flows suggest investors are not throwing money willy-nilly at stocks. While we found small pockets of positive equity flows, investors are hardly reaching for risk on the equity side — at least, not according to their mutual-fund purchases. If any asset class enjoys investor ebullience, it is the bond market, including its riskier side.

Bottom line: Fund-flow data don't portray an investor populace particularly bullish about stocks. Flows indicate investors still seek income and will move further out into the risk spectrum on the bond side in order to achieve higher yields. While the data do not preclude a correction in the equity market, they certainly don't reflect the sort of outlier bullish sentiment that typically coincides with significant market tops.

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