Equity Fund Flows
Marketwatch recently reported a few interesting data points. The first one comes courtesy of Charles Biderman's TrimTabs, which keeps an eye on various gauges of market liquidity and other factors influencing supply and demand for stocks (such as buybacks). So far in 2013, retail investors have apparently put almost as much money into equity mutual funds as in 2000, which continues to be the record year for inflows (it was incidentally also one of the worst possible times ever to buy stocks). However, 2013 isn't over yet. So far this year, $277 billion have flowed into stock funds. There are interesting timing choices visible on the chart showing the monthly breakdown of these inflows. Apart from the record inflow in January, the biggest inflows have been recorded in July, September and October – pretty much at a time when prices were at their maximum distance from the 2009 low, ie. at the current cyclical bull market's beginning (at the time of the low, there were near record high outflows).
So far, 2013 is the biggest year for equity fund inflows since 2000. After nearly 5years of rising prices, retail investors are finally gathering up their courage …
In order to illustrate when retail investors think it safe and when it is decidedly unsafe to buy stocks, we have annotated a chart of the S&P 500 chart below:
The wall of cash into U.S.-listed mutual funds and ETFs (including those that invest overseas) has hit $277 billion, and that’s with just over two months to go in the year, according to TrimTabs Investment Research. That’s the most for one year since $324 billion for all of 2000, which of course is the year the last tech bubble burst.
About one-sixth of that money has been invested this month. TrimTabs says the net $45.5 billion through Oct. 25 is the fifth-highest monthly inflow on record. (The two biggest monthly numbers also came this year: $66.3 billion in January and $55.3 billion in July).”
Consider the following: The SPX only bottomed in March of 2009 – mainly because bank stocks and other financial stocks got clobbered after having been artificially supported by a shorting ban during the 2008 down wave for a little while. Investors at that point realized that the banking system was essentially insolvent, and the Fed's interventions had not yet been supplemented with what proved to be the decisive game changer: a legal method allowing the banks to pretend that they were actually fine, which came with the suspension of mark-to-market accounting in April of 2009.
However, the types of stocks that normally capture the imagination of traders the most, namely big cap technology stocks, had mostly bottomed in 2008 already – right at the point when equity mutual fund outflows reached their record highs.
For instance, in the month when retail investors really bailed out en masse, Amazon was selling below $40. Today, when they deem it safe to wade back in, it is selling at $360. Google was trading at $250 when outflows reached their peak. Now it trades north of $1,000. PCLN was selling for less than $50 at the peak of the outflows in late 2008 – it can be bought for the bargain price of $1,070 today.
There is no need to show all the charts, so we will only present the most egregious one (of a travel agency…which actually has us shaking our head in disbelief)- it should suffice to get the drift.
We actually suspect that these fund inflows are going to grow further and that 2013 will become the record year for equity fund inflows before it is over. We are also bound to see a few more displays of post IPO trading related insanity, especially with the much anticipated Twitter IPO coming soon.
One reason to believe that inflows will continue to grow – barring a surprise financial accident – is that the broad US money supply TMS-2 has grown so much over the past few years that it seems pretty certain that retail investors are going to be tempted to shift some more of the money they have still parked in savings accounts (and earning almost no interest) into equity mutual funds. Of course it must be remembered that the amount of deposit money outstanding does not change on account of such transactions – there is no such thing as 'money on the sidelines' – when retail investors are buying, someone else must be selling to them.
It is a good bet that this 'someone else' is better informed than they are, but it is unknowable at this point when exactly the distribution phase will be over.
Valuation and Corporate Debt
Another tidbit of information that caught our eye can be found in a recent article by Brett Arends, also at Marketwatch. Apart from pointing out that perennial bears like Nouriel Roubini and David Rosenberg have turned bullish, he makes a few interesting points about valuations and corporate debt. In terms of at least one measure of valuation, this is now the second most expensive market ever – the only exception, once again, is the valuation peak of the year 2000. The measure is the combined value of corporate equity plus debt net of cash divided by revenues. In other words, the enterprise value to sales ratio. This what the chart looks like:
Ratio of enterprise values to sales. The highest value ever, except for the 2000 mania peak
Can this measure become more extreme? Sure it can. Does it make sense to buy at such valuations? Not if your time horizon is measured in years rather than in days, weeks or months. Note that with CAPE (Shiller P/E) at about 24, or 50% above its long term average and close to several well known historical peaks (again, the main exception is, you guessed it, the top of the 2000 mania), long term return prospects are likely terrible. The market's value relative to the cost of asset replacement (known as Tobin's Q) is also 50% above its long term average. Note that 'long term average' values are a good distance above the valuations seen at secular bear market lows. Once the market turns, it is not likely that it will simply revert to the mean – it is probably going to revert to the other extreme (possibly by a combination of price adjustments and rising earnings, which would be the optimistic case).
Lastly, we found this remark on corporate debt noteworthy. Arends writes:
“In some ways, the outlook may be even worse than it was in the late 1990s. That’s because there is one enormous difference between then and now. Debt.
The plunge in interest rates that prevailed from 2009 through 2012 sparked a tsunami of new bonds as corporations rushed to borrow. In the past three years, non-financial corporations have borrowed more than $1 trillion, taking their total liabilities above $14 trillion, according to the Federal Reserve. To put that in context, they now owe more than twice as much as they did when Greenspan issued his famous warning in 1996. They have used some of that money to buy back stocks, reducing their overall share count (until they issue new stock to their honchos, of course).”
We already mentioned in the context of the rise in margin debt that increasing debt actually helps stocks on the way up – it is the same with this increase in corporate debt, to the extent that the funds are invested in buybacks. The problems inherent in amassing such huge debt loads only become acute when the cycle turns – then unproductive debt tends to propel a vicious cycle.
Mr Arends also helpfully mentions that “the claim that everybody hates this market is total nonsense”, supporting his view with the mutual fund flow data we discuss above. He is actually saying something quite funny in this context:
“There is an enduring myth out there that “everybody hates this bull market.” If that were true, naturally it would be a bullish indicator, as it would imply there were a lot more people to jump on board.
But it’s not true. It is based on a fundamental misreading of the Internet. Every time someone wants to say that everyone hates this bull market, he links to a few bearish commentators. But thanks to the Internet, any and every opinion is “out there” somewhere. I can find flat-earthers, Aryan Nation nuts, people who think the moon is made of cheese, people who are bullish, people who are bearish, and people who think the universe is about to be swallowed by a giant space frog.
What really matters is not what someone somewhere can be found saying, but what the majority of investors are actually doing. According to the Investment Company Institute, the mutual fund industry’s trade group, John and Jane Q. Public are bullish, not bearish.”
We leave you with two weekly charts of the NYSE index (NYA) and the Nasdaq composite (COMPQ), with their recent price/summation index divergences highlighted. It is also worth noting that the Nasdaq's weekly RSI is approaching the 80 level (it is at 76.08), which is a fairly rare occurrence (but it does not constitute a divergence). As our friend B.A. has pointed out to us, similar breadth divergences were also in evidence in 2007, and at the time, the initial appearance of these divergences did not immediately result in a price peak being recorded.
Instead the market corrected briefly and then surged again, producing another set of price/breadth divergences in the process. It has just done the same thing again, but we would note that there is a big difference in the monetary backdrop: in 2007, money TMS-2 growth had declined to about 2.4% year-on-year, while it is currently around 8% (not as brisk as one would expect in view of $85 billion in 'QE' per month, but recently actually re-accelerating a bit).
So there is reason to suspect that the various extremes we have documented in these pages will be eclipsed by even greater extremes unless some unexpected left-of-field event shatters the current complacency. However, keep in mind that we are not dealing with certainties here, either way. For instance, the market sometimes discounts future monetary developments in advance (as e.g. happened in 1995 when it foresaw accelerated money and credit growth). So the possibility that the recent proliferation of warning signs will suffice to produce a turning point cannot be dismissed. As we have previously pointed out, the only thing that is certain is that risk is currently very high.
NYA and NYSI are diverging … – click to enlarge.
And so are Nasdaq Composite and NASI, with the weekly RSI at an overly generous 76 – click to enlarge.
We'll go eat some moon-cheese, and then we'll grab a few gold coins and look for a place to hide from the giant space-frog that is about to swallow the universe.
Charts by BigCharts, StockCharts, Marketwatch / TrimTabs, Marketwatch / FactSet
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