The Buckingham Report

While the widely-followed blue-chip benchmark has since pulled back into four-digit territory, 10,000 on the Dow Jones Industrial Average didn’t generate much excitement. To be sure, the anchors on CNBC and the floor traders at the New York Stock Exchange donned Dow 10,000 caps for the cameras and the event definitely headlined the mainstream news, but the financial media was surprisingly quick to pan the accomplishment. Looking at a couple of columns in the press penned in the aftermath of the crossing on October 14, the Wall Street Journal wrote, “Dow 10,000: A Caution Sign for Investors,” while CNNMoney admonished, “Don’t Trust Dow 10,000.”

Certainly, from a contrarian standpoint, we prefer a healthy dose of skepticism, as history shows that stocks often climb a ‘wall of worry’ and we’ve learned over the years that market peaks can come in times of great euphoria (think back to early 2000, in the wake of the successful navigation of Y2K and the great infatuation with the ‘New Economy’) and troughs can coincide with periods of maximum pessimism. Thinking of the latter, investors were about as terrified as they’ve ever been the first week of March this year, and not surprisingly, that period has thus far proved to be one of the best times ever to have been picking up stocks.

In fact, looking at investor sentiment figures from the American Association of Individual Investors (AAII), for the week of March 4, 2009, AAII members who responded to the bullish/neutral/bearish question were overwhelmingly negative with only 18.9% saying they were bullish versus 70.3% saying they were bearish. That difference of 51.4% was higher on only one other occasion in the 22-year history of this weekly gauge. When was that worse reading recorded? October 19, 1990. When did the market bottom that year? That same week! 

Last week, the AAII weekly survey showed bulls beating bears by about 5 percentage points, but this week’s selloff has sent the optimists scurrying as the latest read shows the bears beating the bulls by almost 9 percentage points. Historically the AAII folks have tended to be an optimistic bunch with a 9 percentage point gap on average favoring a bullish outlook, so this contrarian indicator is in the favorable camp today. Of course, other measures, including indexes from Investors Intelligence, have been a little more upbeat, so the sentiment picture is somewhat mixed.

That being said, one can make a case that mutual fund flows are of greater importance in surveying investor attitudes toward stocks. After all, it’s one thing to say you’re bullish or bearish, but it’s another to actually act upon the thinking. Both Morningstar and the Investment Company Institute (ICI) compile data on estimated mutual fund net flows with the numbers suggesting that optimism is not exactly the dominant view nowadays when it comes to U.S. equities, despite the tremendous rally seen off of the March lows.

Surely, the data are not to be construed as all encompassing as flows for hedge funds, separately managed accounts and other investment vehicles are not available from these sources, but consider that Morningstar’s latest Fund Flows commentary (based on September 30, 2009 figures) states, “Bond funds continued to capture the vast majority of the inflows in the third quarter. Meanwhile, flows into equity funds have been tepid in spite of the broad stock market recovery. Although the S&P 500 has gained more than 19% so far this year, investors have placed only a net $3.8 billion back into U.S. Stock funds.” And September actually saw $3.1 billion leave domestic stock funds. By way of comparison, $96 billion flowed out of U.S. stock funds in 2008, so fund investors have been fickle for quite a while.

Though data for Exchange-Traded Funds (ETFs) is highly volatile with Morningstar suggesting that movements out of the S&P 500 tracking SPDR (ticker symbol SPY) account for nearly all of the negative flows this year, the money fleeing U.S. stock mutual funds does not seem to be finding its way into U.S. stock ETFs. A net $30 billion has left domestic equity ETFs with $4.3 billion departing in September alone. Where did the money go? Taxable Bond, Commodity, Alternative and International Stock ETFs, in that order. To be fair, U.S. stock ETFs (including leveraged and inverse) did see $111 billion in net inflows during 2008, so a lot of the mutual fund redemptions last year headed for this supposedly greener pasture.

Click here for the full October 12, 2009 Morningstar report: http://morningstardirect.morningstar.com/clientcomm/2009-09_FundFlows.pdf

The Investment Company Institute offers weekly updates of flows into long-term mutual funds. ICI is the national association of U.S. investment companies, including mutual funds, closed-end funds, ETFs and Unit Investment Trusts, and its members collectively manage more than $11 trillion and serve nearly 93 million shareholders. The group’s Web site is full of terrific information and we think the 2009 Factbook is especially interesting. Click here to view: http://www.icifactbook.org

The chart below vividly illustrates the dislike investors have had for U.S. equity funds as well as their affection with bond funds over the past five weeks. Not ready to declare a bubble in bonds, but it is interesting that ICI fund flow data dating back to 1994 shows the biggest inflows into equities in early 2000, while outflows were heaviest in late-2002 and late-2008.

Additional information on the actual moves that investors are making can be gleaned from Hewitt Associates, the provider of human resources services to companies all over the world, and who since 1997 has maintained the Hewitt 401(k) Index. This barometer tracks the daily transfer activity of nearly 1.5 million 401(k) plan participants with nearly $90 billion in collective assets. Hewitt states that it provides information on how market events affect plan participants’ investment decisions and market confidence.

The latest commentary (September 2009) from Hewitt reads: “401(k) participants continued to slowly and modestly transfer assets from fixed income investments back into equities, according to the results of the Hewitt 401(k) Index. Total transfers for the month of September were again equity-oriented. However, flows overall have been relatively small, as only 1% of total assets have shifted from fixed income to equity investments since April 2009. On the other hand, 6% of assets transferred from equities to fixed income between January 2008 and March 2009.”

Despite the modest increase in equity exposure, Hewitt says that participants' overall equity holdings stood at 57.2% at the end of September, which represented an increase of 3.6% for the quarter, though strong stock market returns as opposed to major flows toward equities, garnered the credit. While the overall balance in stock investments was lower last year and earlier this year, it is interesting to note that there has been no other period in the 12-year history of the Hewitt index, including 2000-2003, when the metric showed such a light exposure to equities, even as we realize that the carnage in 2008 mathematically lowered equity weightings for just about everybody.

Alas, the road that individuals, as investors, take through life will have many ups and downs as so much is riding on the health of our economy and our markets. No doubt, the volatility endured in the past year has caused many to stray from the long-term paths they had been treading and we fear that some investors have become so cautious that they've put their portfolios at the mercy of inflation over the long term.

Clearly, contrarian indicators like bull/bear surveys and fund flows alone aren’t ‘gonna set my heart at ease’, but with the favorable interest rate backdrop and many undervalued stocks offering generous dividend yields, we think that those with minimal exposure to domestic equities should still be thinking about taking that sentimental journey home.

Now more than ever, we believe that it's valuable for investors to have ready access to prudent commentary about the economy and the market upon which their life's financial course is dependant. To learn more about The Prudent Speculator newsletter as well as the various products that Al Frank Asset Management offers, please visit www.alfrank.com

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Al Frank Asset Management, Inc. (Al Frank) is an Investment Advisor, registered with the Securities & Exchange Commission and notice filed in the State of California and various other states. All material published by Al Frank is subject to change without notice. These materials are the opinions of Al Frank and the performance of any investing strategies discussed, as well as securities mentioned are subject to risks and uncertainties beyond the control of Al Frank. Additionally, these materials should not be considered investing, tax or legal advice. All investing involves the risk of loss as markets are inherently volatile. Small and mid-cap stocks are typically more volatile than large cap stocks. All materials not published by Al Frank are considered outside the control of Al Frank and are not representative of its views or opinions.

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The Dow Jones Industrial Average Index, also referred to as the Dow, is computed from the stock prices of thirty of the largest and most widely held public companies in the Unites States.  You cannot invest directly in an index.

An exchange-traded fund (or ETF) is an investment vehicle traded on stock exchanges, much like stocks. An ETF holds assets such as stocks or bonds and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day.