Be Different – Love US Stock Mutual Funds

Thursday, October 29, 2009

Be DifferentAny savvy shopper knows that the best time to buy swimsuits is when everyone else is buying parkas. The same applies to investing. To “buy low, sell high” successfully, we must go against the crowd at times. When many are focused on one thing, it is a time to be wary – chances are, prices are too high. Likewise, when investors are worried, it is time to be interested because prices could be low. In today’s market, that means being wary of bond mutual funds and being interested in US stock mutual funds. Here’s why…

First, to set the stage. Yes, the stock market is up a lot from its dismal March lows, but many investors remain doubters or worry about buying in now. By the end of last year, even some institutional fund managers had sworn off stocks. They anticipated a long, drawn-out bear market. The drop in March seemed to prove their case.

Since then, though, the market has risen sharply and quickly, leaving those investors behind. Now, they are in a predicament: buy now, admitting they made a mistake, or wait, hoping something will make the stock market drop again. One professional said it well: “Certainly the market’s trickier here, as more people have been dragged reluctantly into it.”

Now, let’s look at individual investors. No bull market ever ended without high optimism and heavy investing by individuals. Mutual fund flows are a good measure of their beliefs. What we find is they have yet to be dragged into US stocks, much less become enthusiastic. Rather, they remain focused on buying bonds, while worrying about stock market risk. This thinking can be seen in the following graphs (source of data: Investment Company Institute).

First, a look at the monthly mutual fund flows through August:

MF flows-1

Next, a weekly update through last week:

MF flows-2

Clearly, investors prefer bonds and are avoiding stocks. To look further, we see that the latest week’s positive stock flow is due to international stock fund buying only:

MF flows-3

So, it looks like an opportunistic time to focus on US stock mutual funds and continue to avoid bond funds. And remember that if the US dollar starts to rise, it will have a drag on international stocks because of the exchange rate.

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