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Adam Sarhan MarketWatch Quote: Suckers or saviors? Small investors buy up stocks

Market WatchMarket Extra
Feb. 5, 2013, 11:37 a.m. EST

Suckers or saviors? Small investors buy up stocks

Fund flows offer no guide to future stock moves, says one analysis

By William L. Watts, MarketWatchFRANKFURT (MarketWatch) — Are mom and pop stock investors late to the party again?
Individual investors at long last have begun pouring money back into U.S. stocks as indexes hit five-year highs. But hopes the renewed flows will extend the rally, which pushed the Dow Jones Industrial Average (DJI:DJIA)  back to 14,000, are tempered by fears the recent participation by retail investors may be marking a market top.
For a start, the data on investor stock flows isn’t a reliable guide to market direction, according to one analysis.
“It’s not a signal about where the market is heading,” said Brad Barber, a finance professor at the Graduate School of Management at the University of California, Davis, whose research focuses in part on investor psychology. He noted that on some occasions fund flows have peaked just as the market prepared to tank.

That was the case nearly three years ago. Data from the Investment Company Institute, or ICI, shows mutual fund flows turned positive in March and April 2010, just as the S&P 500 (SNC:SPX)   hit a 30-month high above 1,200. The index then tumbled below 1,011 in July before regaining its footing. Flows also turned positive in April 2011, with the S&P 500 setting its peak for the year a month later.
Read more on U.S. stocks.
But others contend that when viewed in context of the overall market backdrop and fading tail-risk fears, the data offers bulls some limited reassurance.
The ICI on Friday said $6.35 billion flowed into equity mutual funds in the week ended Jan. 23, including $3.49 billion into domestic U.S. equity funds. That brought the total flow into domestic U.S. mutual funds for the first full three weeks of January to $16.1 billion — on track for the first positive month since April 2011.
Investors also piled into exchange-traded funds in January, with around $8 billion pouring into U.S.-listed ETFs last week mostly oriented toward U.S. and international stocks, according to IndexUniverse.
On its website, the ICI notes that there is “no established correlation” between mutual fund flows and stock market activity.

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“Mutual funds own only about 20% of the total U.S. equities outstanding. Larger percentages are owned directly by U.S. and foreign individual investors, domestic pension plans, and state government retirement plans. In order to measure total demand, you would need information on the activities of these investors in addition to mutual fund cash flow,” the ICI explains. “Unfortunately, comparable data is not available on non-mutual fund investors.”
Indeed, it is notable that the rally from the 2009 lows has come as individual investors appear to have shunned equities, noted Nicholas Colas, chief market strategist at ConvergEx Group in New York.
Over the course of the rally, investors have withdrawn around $365 billion in capital from U.S.-listed funds that specialize in domestic stocks, he said. In 2012 alone, as stocks rallied sharply, investors pulled $151 billion from domestic U.S. stock funds, Colas said, while $256 billion flowed into fixed-income funds.
ETFs focused on domestic stocks saw around $58 billion of inflows, but that accounted for only a third of the $174 billion that flowed into all ETF products, he said.
So is there any reason for bulls to cheer?
The positive flows are “one piece of a bullish puzzle that I’m seeing,” said Adam Sarhan, chief executive of Sarhan Capital in New York.
It fits in with other factors “that suggest this market wants to continue trading higher,” Sarhan said.
Those other factors include valuations that remain attractive, earnings growth, solid prospects for continued economic growth, and indications that global central banks are poised to continue taking steps aimed at ensuring the global recovery remains intact.
Avi Nachmany, director of research at Strategic Insight, said he suspects the turn reflects an important and potentially positive turn in investor attitude.
Individual investors are fretting less about politics and issues such as the fiscal cliff, instead taking a more upbeat view on the economic outlook thanks to rising home prices, falling unemployment and fading memories of the 2008 financial crisis, he contends.
In that vein, it appears investors are also seeing less of a disconnect between rising stocks on Wall Street and their own situations, he said.
“If you make the assumption that slow and persistent economic improvement continues in the U.S., then what we saw in January is the future,” Nachmany said.
The recent decline in market volatility may also be a big part of what has lured individual investors back into stocks, said ConvergEx’s Colas.
The rally from the 2009 lows has been marked by some ugly corrections, which have spooked investors, likely leaving them wary of jumping back into the market due to fears they could be immediately clobbered.
Wall Street’s fear gauge, the CBOE Volatility Index, or VIX (MDE:VIX)  , last week sank to its lowest level since mid-2007.
So with fear receding, greed — that other storied driver of market action — moves to the fore.
Meanwhile, investors stuck with money parked in low-yielding money-market funds and bonds may be understandably itching to seek out higher returns, said Barber at UC Davis.
Observers, however, are treating the January jump in flows with extra caution due to concerns 2013 tax changes and new rules limiting deposit insurance on bank and money-market accounts triggered a rise in flows to equity and fixed-income funds alike.
Rather than a “Great Rotation” out of fixed-income into equities, January may have marked a “rotation out of money-market funds and bank accounts that no longer have full FDIC (Federal Deposit Insurance Corp.] insurance,” Mohammed el-Erian, chief executive of Pimco, the world’s largest bond fund operator, told Bloomberg Television last week. Watch video of Pimco’s el-Erian.
Pimco colleague Bill Gross expressed similar skepticism in comments over Twitter. Read Gross on the ‘Great Rotation.’
Colas held out the possibility the January data was skewed by investors jumping back into the market after making heavy redemptions late last year in anticipation of tax changes in 2013. ICI data showed investors pulled an “inordinately large” $26.1 billion out of domestic U.S. equity funds in December.
“I would want to see several months [of rising inflows] to be convinced investors are falling back in love with stocks,” Colas said.