We reported recently that Bank of America strategists are expecting a "great rotation" out of bonds and into U.S. stocks this year. So far, things are going their way – but you have to wonder if this sudden interest is a cause for concern.
Investors have been notoriously shy of stocks during the recent bull market, with trading volumes low and stock ownership proving a hard sell. For all of 2012, a net $3-billion (U.S.) flowed into U.S. stock funds and exchange traded funds, which is tiny.
But for the week ended Wednesday – which coincided with the recent resolution to the U.S. "fiscal cliff" crisis – interest in stocks picked up in a big way: A net $18-billion flowed into stock funds, sailing past the biggest week of inflows in 2012. In fact, according to Bank of America (via The Wall Street Journal), the week's inflows mark the biggest since June 2008 and the fourth largest since 2000.
The trend appears to be global. According to EPFR Global (via Bloomberg News), $22-billion flowed into equity funds around the world during the same week, which is the second biggest inflow into stocks for data going back to 1996.
If this marks the start of a trend in which small investors become reacquainted with the upside of equities, the stock market could get a nice boost. Investors moving into a market, after all, tend to drive prices higher. And there are some good reasons for a move into stocks: The U.S. economy is likely to get a tailwind from a recovering housing market and an increase in state spending, for starters.
But disinterest among investors has long been cited as a contrarian reason to stay bullish on stocks, even after the S&P 500 had more than doubled from its low in early 2009. According to this line of thinking, money sitting on the sidelines – or piling up in bond funds – implied that the market was not yet reflecting too much exuberance on the part of investors.
Perhaps that exuberance is now on its way. Earlier this week, the American Association of Individual Investors reported that bullishness among small investors spiked above 46 per cent from about 39 per cent, hitting an 11-month high.
And the CBOE Volatility index, which is a popular gauge of investor anxiety, continues to slide in the wake of the "fiscal cliff" agreement on New Year's Day, reflecting few concerns on the part of investors. The VIX fell to 13.5 on Friday afternoon, down from above 22 in late December and very close to a five-and-a-half year low.
The flow of money into stocks could be nothing more than a one-week thrill-ride by investors relieved that the U.S. economy wasn't going to be skewered by disagreement in Washington. But if small investors are indeed starting to embrace stocks, one of the key contrarian arguments used by bullish strategists – investors shunning equities – could vanish.
Here's an ugly fact to think about: According to EPFR, the biggest-ever inflow of money into stocks was $23-billion, in the third week of September 2007. As Bloomberg News pointed out, that was a month before the S&P 500 hit a record high – suggesting the inflows came near the end of a bull market.