Investors Still Wary of Stocks

Milton Ezrati

Chief Economist

Media, until recently, carried several stories about improved investor climate, in particular how the index of fear has dropped to levels not seen in years. On its own, such news would actually give cause for concern. It might imply that investors have developed the kinds of enthusiasms that drive markets too far too fast and set them up for a correction, perhaps some time this coming summer. Fortunately, money flows have continued to signal the opposite. Instead of undue enthusiasms, they tell that investors, despite past price gains, remain wary of equities and imply that ample buying power remains to carry the rally further. Of course, there are always dangers. Policy disappointments could bring down stocks, as could shocks from abroad. But at least the picture on investor behavior remains reassuring.

Except for a rough patch or two, recent market action certainly tempted a dangerous enthusiasm. Right after the election, stocks took off. The S&P 500 index, a good gauge of the market as a whole, jumped 4.6 percent from November 8 to year-end 2016. It gained another 5.5 percent over the first quarter this year and rose almost another 2.0 percent during April and into late May, even incorporating the brief, politically induced selloff.

But investors seem to have resisted any temptation to chase gains. Quite the contrary, in fact, they have exhibited a continued preference for bonds. According to the firm Dealogic, both individual and institutional investors during the first quarter, the most recent period for which complete data are available, purchased more debt than ever from companies and governments, almost $180 billion dollars in fact. During this time, they bought almost $80 billion in junk bonds, double the amount they bought during this time last year. And it seems that the pace of bond buying picked up through April, though complete data are not yet available. Either these investors are desperate for income, which is possible, or unenthusiastic about equities or both. Either way, such patterns have made clear that equity investors remain far from any kind of undue exuberance.

Figures available from the Investment Company Institute (ICI) confirm this picture. To be sure, these statistics cover only mutual funds and exchange traded funds (ETFs), but they are nonetheless indicative of general patterns. At least they have done so in the past. According to the ICI, investors redeemed $28 million from domestic equity mutual funds as prices rose during the first quarter and an additional $14.6 million in April, the most recent period for which complete data are available. More recent, though tentative data show that such sales actually accelerated during the initial weeks of May. Though these net withdrawals are less than a percent of amounts outstanding, they nonetheless speak to caution not exuberance among equity investors. In contrast, mutual fund buyers increased purchases in bond funds. Inflows here amounted to some $102 million during this time. Relative ETF flows were more moderate but similar.

These patterns say two rather forceful things. First, investors seem to have little fear of losses in bonds. They have continued to buy even though many have warned of the inflationary implications from past floods of Fed-provided liquidity into capital markets and the Federal Reserve (Fed) has made clear its intention to raise short-term interest rates. Second, and more immediately significant, investors show no inclination to chase past equity price gains and in the process set the market up for a correction. Of course, other influences would cause equities to retreat, a failure by President Trump to deliver on his market-friendly promises or several potential problems in Europe. But at least market tacticians can dismiss the dangers of undue exuberance among equity investors.