Friday, February 08, 2013

Money is Flowing Into Stock ETFs But Not Into Stocks

I had an opportunity yesterday to speak with Lauren Simonetti at Fox Business. Unfortunately, the link to the video is not yet available, but one of the things we discussed was the current rally in the market and if this is a good time to get into stocks. I pointed out that individual investors typically have a bad record when it comes to market timing. They tend to pour money into stocks after the market has already rallied and they tend to wait until the market plunges before pulling their money out.

Here's a graph published by the Investment Company Institute (ICI) that depicts this behavior nicely for mutual funds. For example, investors kept pouring money into equity mutual funds from 2000 to 2002 as stocks were falling, but they started pulling money out after the bottom was reached. They put money back in from 2003 to 2007, but much of the money came back after much of the rally was already over. The financial crisis of 2008 caused stocks to plunge, but investors kept pulling money out even after the bottom was reached. The 2008 sell-off was so scary that investors stayed out of stocks even as markets rallied in 2009. Even though stocks went higher, the extreme level of volatility continued through the end of 2011, causing investors to keep pulling even more of their money out. Things settled down quite a bit in 2012 and the market rallied by double digits. The lower volatility and the double-digit gain seem to have enticed investors back into the market.

Money is now flowing into equities at a record pace. This activity will probably push stocks higher, but probably only for the short run. If the past is any guide, investors are probably late to the party and most of the rally is likely over.

There are a couple of things, however, that are different this time around. In the past, investors liked to buy individual stocks. They are not doing that as much this time. Instead, they are going into funds, especially exchange traded funds (ETFs). What's more, they are avoiding the actively managed funds in favor of those that are passively managed. It appears that they have doubts about the value of active management. All they want is equity exposure, which they can get at low management fees using ETFs that track indexes.

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