Below are a series of charts that attempt to summarize the actions of the retail investor. Of course everyone knows that stock funds have dramatically decreased in value from their 2000 highs, and the media has reminded us how much money has been lost. The question however is how much money does the individual investor have left, because money and a propensity to purchase stock are the fuels that can propel the market higher. These charts below will illustrate where the money will come from and where investor interest exists.
The first chart examines the amount of money that mutual funds.manage or control. It is a chart of the Net Assets of all US mutual funds in Billions of US dollars. There are three categories of assets: Equity or stock funds (SF), Bond funds(BF), and Money Market funds(MMF). These three groups are combined to form a composite or total of all funds assets. Lastly, the monthly closing Dow Jones Industrial Average (DJIA) is plotted for reference.
First, look at the three categories. What's interesting here is that despite the fact that the US treasury market and the bond markets are larger in size than the stock market in dollar value, the total net assets of BFs are less than the SFs net assets. This shows that the individual investors perferred putting their money into SFs rather than BFs. And this was a good choice, up until 2001.
Notice that the SFs peaked in the Summer of 2000 at $5 Trillion and were less than $3 Trillion in Oct. 2002. As for BFs and MMFs they were steadily rising up to Oct. 2002. The media has sensationalized the stock market's loss, but if you look at the combined total net assets figures (red line), it shows that the loss in holdings only dropped by $1.5 Trillion versus the $2.1 Trillion lost in the SFs. Currently, a year later Oct. 2003, Mutual Fund Investors combined assets is only down $0.3 Trillion! The conbined total Net Assets are almost back to peak levels! The chart shows equity and bond funds rose while money market funds fell.
This causes us to ask where did the money go? How much money is left to invest? Will the individual investor return to the market? The chart tells us that the individual investor shifted money from SFs to MMFs and BFs tempering losses. But how much new money is coming into the SFs. How much buying is coming from mutual funds right now? The answer to these questions will come later on this page.
Lastly, the current status is that individual investors still own more stock than bonds and cash, and there is more cash sitting in MMFs than ever before. Also note that in the last three months cash has been disappearing from MMFs. We can't assume that the decrease in MMFs means that investors are buying bonds or stocks, it could also mean that they need the money for other purchases; they're spending it. But, notice that there is more cash in MMFs than there was in the late 1990s. So investors aren't broke, yet.
For a research paper on "Market Returns and Mutual Fund Flows" by Eli M. Remolona, Paul Kleiman, and Dibbie Gruenstein, visit the New York Federal Reserive Bank's website to read their research paper.
Below is chart that demonstrates in percentages how funds have shifted. Here the net assets of each category are displayed. The only class of funds inceasing is size currently are the BFs. Even the MMFs are decreasing is size from year ago levels. So individual investors are using there cash. The question is what are they spending it on.
Below is shows how much the SFs have in liquid assets. There are three plots. 1. The amount of liquid assets as a percent of assets. 2. SFs total net assets in billions. 3. The converted amount of cash available in billions to fund managers to purchase stock or service investor redemptions.
Translated, liquid assets means how much cash is available in relation to total assets. Notice that this only applies to the SFs. We didn't create other charts for the other categories since the SFs represent the largest class of mutual funds. Next look at the left scale. It is in hundredths. Convert this to percent and you'll see that the SFs keep between 4% and 6.5% of their assets in cash. This allows them to handle both investor customer service needs and management needs such as redemptions, fund transfers, and stock purchases.
Notice that SFs had over 6% cash during the financial crisis of 1998. These funds then invested the money and only had 4% cash by Feb 2000. Then after the top in 2000, the cash position quickly rose to 6.5%. This can have several meanings. First, investors were still pouring money in to SFs. Second, SFs were selling positions and realizing profits, or three, a combination of both. But this chart can't answer that question. It does show us that from 2000 to 2003, SFs have been slowly decreasing their cash position to levels seen near the top of the market in 2000. The question that remains is whether investors have been liquidating their positions; redeeming their funds, or have the SFs been buying stock.
Lastly, notice that although SFs cash levels are need the low end of their range, they still have $1.6 Trillion sitting in cash.
Next, let's examine the individual investors reactions to stock prices. The question posed above "what caused the spike in liquid assets from 4% to 6.5% in 2000?" is answered here. The individual investor poured money into SFs in 2000 creating a huge positive cash inflow. SFs couldn't invest the money fast enough and therefore it showed up in the spike of liquid assets. Since 2000, investors have been putting new money into SFs but at ever dwindling amounts. Currently the inflows are at their lowest levels, but notice the anomally. The last time inflows were this low was back in Sep 2001. At that time stock prices reached a low and the country was paralyzed by 9/11/01. Americans didn't think about money. Now we are at lower stock prices than in 2001 and the individual investor isn't putting money into SFs. The good news is that the redemptions are decreasing, but new money isn't entering the market as quickly as it did back in 2000. Second, notice that during the 2000 highs redemptions were also quite high. Not as high as new money coming into SFs but historically, there were numerous investors pulling out of the market.
Net exchanges are funds moving around from one fund to another and are in the redemption zone. The net new cash flow is also currently in the redemption zone so investors are pulling money out of SFs. So in reference to the chart above, the dwindling cash supply of SFs has mainly been related to investors leaving the market over the last year.
Lastly, this chart shows the net new cash flow in Millions per month and notice that the amount of redemptions in July 2002 was less than the amount of redemptions in Sep 2001. The stock market made a lower low but fewer individual investors had cashed out. Then look at the redemption amount for October 2002, it was less than July 2002, and third, look at the redemption amount in February 2003, it was still less than the other two steep declines in the stock market. What this is telling us is that their no fear and panic in the minds of the average individual investor and they're not cashing out their holdings. This could be considered "strong hands" by some since those fearful of future declines have already left the stock market. But time will tell if these investors are the savvy ones, or the "last Mohicans" to fall.
So the chart shows us that the net cash entering the stock market from individual investors is slowing and the rate of redemptions is slowing. There's no sign of fear yet and individual investors aren't buying the dip in stock prices.
So what's going with the stock market internally. Prices have been range bound since May 2002. But the range keeps making lower lows and lower highs which tells us the downtrend is still intact. But how much longer will this continue. The graph below examines what's taking place internally with the stock market. This chart below shows that since May 2002, somebody's been buying and buying in a big way. But we just examined the data from the Mutual Funds industry and concluded that it isn't the indvidual investor that is buying, so who is it and why? The second question that has to asked and ultimately answered is when will this buying binge end, and when it does, will prices fall.
Note that in the first quarter of 2003 (Q1), investors were nervous due to the impending war with Iraq. It was touted that if the USA won the war in Iraq, the market would rally, but in fact it didn't. It rallied as the war began and it remains to be seen what will happen next. But despite this nervousness, somebody has been buying this market. The up/down volume ratio and the advance/decline ratio show a surge in buying both on a semi-annual and quarterly periodic basis. And notice that this buying is at unprecented levels. These current levels even exceed the highest levels of the strongest bull market ever seen. So this buying binge is huge. The problem is that prices aren't showing any propensity to change direction. As of 4/16/03, the stock market hasn't reversed the downtrend. Prices are rising but they are still stuck below previous highs and are at key resistance levels. So a smart investor has to ask, if all this buying can't push the market high enough to break the downtrend, then what will?
Well, let's take a look at the derivative market and see what they're up to. First, let's examine the futures market. It is quite apparent that the professionals are now net long in a huge way. They net long over 100,000 SP500 contracts which is double the amount they were net long at the low of 1998. At no other time in history have the professional investors been this one sided. What if they bet that the stock market will rise once the USA wins the war in Iraq and it doesn't rise enough to break the downtrend?
Next, let's look at the option market. The total open interest has been steadily growing and is near its all time highs and is now over 100 Million option contracts. They trade over a 1 Million contracts a day and the value of money exchanged is over $2 Billion. So option market can't be ignored. Also notice that each January marks a major decline in open interest. Apparently, there is a huge volume of options that is hedged against the calendar year on an annual basis. The only concrete data derived from the option data is that of its size. The second fact is that options are predominanly used by professionals and demonstrate like the index futures market that professionals dominate these markets.
So the individual investor isn't behind the current buying spree, and it appears that the professionals are making a huge bet that the market will push higher. But why are they interested in stocks when we're in a climate of declining corporate profits and increasing unemployment. Well, the answer is because all things are relative. Another piece of the puzzle lies with the flow of money between investment classes. If you look at the chart below, you'll see that the rate of return on the DJIA over a ten year period has just turned down but the 5 year average annual rate of return is near historic lows. So according to the chart below, investing in the DJIA has been a poor investment during the last 5 years. Well, we all know that but did you know that this past 5 year period has been one of the worst. Well, the professionals know this are playing the odds. They are betting that the stock market will provide positive returns and approach the ten year average return rate of 10%. This would cause quite a stock market bull move, but what if they're wrong and the DJIA attempts to repeat the all time worst five year period in the near future? This would mean that the next stock market wave would be catastrophic and it would be the result of the professionals bailing out of the stock market. They will themselves create this fiasco by rushing to the exits as fast as they can since they can only sell to themselves. By this I mean the individual investor can't possibly match the buying power of these behemouths and so there will be a huge volume of selling that can't be absorbed which will drive prices to the ground. Basically, they will reverse themselves and undo all that buying that's been occurring over the past 6 months. I don't believe they will hold on to the stock as prices decline. At first they will begin by hedging their current stock holdings using options and futures but at some point they will need to cover their losing positions and sell the stock.
By the way, notice the 30 to 40 year cycle in the 10 year average DJIA rates of return. What do you think will happen next?
Now let's look at how the stock market has changed relative to other markets such as the US dollar, Crude Oil, and Gold. Below is a chart that shows how prices have changed relative to June 1996. This elementary intermarket relative strength comparison quickly shows us how these four market's price movement behaved. In fact, the US dollar is still stronger than it was back in 1996; stocks are still priced higher; crude oil is higher, but gold is lower. What's interesting to note is that while crude oil rose in price from March 1999 to September of 2000, the stock market also rose. Then crude oil and the stock market fell together until April 2001 when they disconnected and reacted independently. What's interesting to note is that if high crude oil prices are such a burden on corporate America then why didn't stock prices rally up in September 2000 when crude oil prices declined. This glaring disparity teaches use that there are no axioms in finance. As the old adage says, "rules are meant to be broken". Another interesting disparity occurred with the US dollar. Despite the Treasury's efforts to devalue the US dollar by increasing the money supply (huge increases in money have been injected into the banking system), the US dollar is still stronger than it was back in1996. It's been decreasing in value lately but it is still relatively stronger than it was. Lastly another disparity is with gold. Gold is finally responding to the US dollar's decrease in value by rising, but the correlation between these two markets is lower than is perceived. Since June 2003 the US dollar is rising in value and so is gold. So the the traditional view that gold prices and the US dollar's prices are inversely related needs to be disguarded.
This story isn't finished as we have yet to include the global perspective and the impact of interest rates, currency rates, and energy prices. Stay tuned for more. Visit us frequently.