Here’s a thoughtful question from a longtime reader. How can various commentators (myself included) say that investor sentiment toward the stock market is excessively optimistic when billions of dollars continue to flow out of U.S. stock mutual funds?
There are several answers to this paradox. One is that plenty of money is flowing into certain types of funds — not traditional actively managed mutual funds, but ETFs.
For example, the granddaddy of exchange-traded funds, the Standard & Poor’s 500 Spyder (NYSE: SPY), had 677.7 million shares outstanding as of Sept. 30, 2009. A little over a year later, with stock prices considerably higher, that total has jumped to 730.8 million shares.
But the ETF phenomenon doesn’t fully explain the dollar drain out of traditional mutual funds. For the rest of the story, we have to go back to the 1970s — the last lengthy period when U.S. stocks fluctuated widely without making any net progress.
Every year from 1971 through 1981, investors sold more mutual fund shares than they purchased. Were all these sellers bearish on stocks? Some were, no doubt. But many more, I suspect, were simply rebalancing their portfolios toward lower risk ahead of an important life event: retirement.
In the 1970s, America experienced a miniature version of the Age Wave now sweeping our country (and just about every other industrialized nation). If past is prologue, I think we’ll see several more years of net mutual fund selling, at least until the Boomers have achieved a retirement asset mix they can live with.
Meanwhile, the folks who have stayed in the stock market game are indeed extremely bullish. Just today, the American Association of Individual Investors reported that 58% of their membership is expecting stock prices to rise over the next six months — the highest proportion since January 2007, just a few weeks before a sharp (but temporary) market drop.
The respected Consensus poll of professional advisors shows 71% bulls, a mere two points below the reading in late April — again, just before a serious setback. Put-call ratios also indicate a high degree of complacency.
None of this stuff means the market has to skid immediately. Taken together, though, the evidence argues for great caution with new purchases. For aggressive investors, hedging may be in order soon.
In today’s trading, Cisco Systems (NASDAQ: CSCO) plunged after giving a weak sales forecast for the current quarter (3%-5% growth, about half what analysts were expecting). I’m disappointed, too, enough to downgrade the stock to a hold — no recommended buy price.
But I’m more concerned about what the Cisco news may imply for technology capital spending in 2011. If we receive more signals of a tech slowdown in the days ahead, it may become necessary to cut the cord on IBM (NYSE: IBM) and Oracle (NASDAQ: ORCL), two big winners previously. Stay in touch.
On a happier note, I’m pleased that some popular utility stocks are coming back down into decent buying ranges. New Jersey-based Public Service Enterprise Group (NYSE: PEG) has traded below my $32.30 buy limit during each of the past three sessions.
PEG is a safe, well-run outfit with a generous +4.3% yield. Buy now to capture the next dividend, due in late December.
