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Mutual fund flows show investors are still very bearish

As the equity market moves higher, to new post-recession ground, many argue that investors are becoming too bullish, and this exposes the market to lots of downside risk should the economy stumble again. I've seen surveys that say bullish sentiment is relatively high, but surveys are one thing, and real money moving around is another. So I put together these charts, which compare the net monthly flows into and out of equity and bond mutual funds with the level of the S&P 500 index. The data on fund flows comes from ICI.

As should be quite obvious, retail investors haven't added more than a few drops to equity mutual funds for the past 5 years. Maybe $40-50 billion here and there, but that's nothing; since the beginning of 2007, investors have withdrawn a total of more than $470 billion from domestic equity funds. Withdrawals have been huge and relatively steady until last month, when net flows were close to zero. If retail investors were really turning bullish, we should have seen big inflows in the past several months, but we haven't seen any. To be sure, retail investors are typically slow to react to changing conditions. But all that means is that retail investors have yet to believe that stocks are worth buying. The upside in the equity market has all come from a change in the relative attractiveness of stocks; the economy has done better than expected, so those who still hold stocks have become reluctant to sell. And as we know, volume in this rally has been very light.

As for bond funds, inflows have been gigantic, totaling over $840 billion, and they are continuing, even though bond yields are close to generational and historic lows. But of course that's why yields are so low: investors are terrified of taking on equity risk, and are willing to accept extremely low yields in exchange for a modicum of security. The big flows in the markets are being driven by fear, not by greed.

Adding it all up, I would say that we are a long way from seeing over-priced equities. Let's wait to see many months or even a few years of inflows to equity funds before concluding that the guy on the street is too bullish.

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