Avi Nachmany, Director of Research, Strategic Insight, an Asset International Company


I Googled Warren Buffet's eloquent quote from the depth of the recent economic crisis. Joe Weisenthal at The Business Insider Website (http://www.businessinsider.com/joe-weisenthal) made the intriguing observation that one should ignore the optimistic statement ("There's no way you can bet against America and win"), focus instead on his recent investments in Burlington Northern, Exxon and Wal-Mart: "He doesn't see us, at least right now, as some glimmering, efficient, modern city on a hill," Weisenthal writes. "We're a crowded country, using coal, paying out the nose (if) we can afford to go to the pump, while buying our Nestle (also a new holding) junk food at Wal-Mart."  

While spiking stock prices worldwide are signaling economic recovery (and in some markets even euphoria), investors in stock mutual funds in the US remain cautious, as mirrored by what they do with their money. Strategic Insight always chooses to observe what individuals do with their personal cash flows and focus less on what individuals report as their improving or deteriorating sentiments.


Phil Herzog, our Chief Technology Office, and I invented the methodology of calculating mutual fund cash flows 20 years ago. This is still a unique algorithm which each month SI fine-tunes by $15 billion to $20 billion before we publish the data in our Simfund database, which tracks the nation's $12 trillion of mutual fund assets. [You can learn more about us here: http://www.sionline.com/aboutsi/default.asp.] What do we learn by watching the cash flow actions by investors in stock mutual funds? Their purchasing activity since the stock markets started to rebound remained very cautious. The remarkable rise in stock prices the past nine months was not followed by corresponding significant increases in stock fund purchasing. As the graph below shows, sales of stock funds rose only slightly since March.



With little pickup in purchasing and little net purchasing (purchases less withdrawals) of  stock funds in the second half of 2009, it is clear that the record recovery of stock prices has not been supported by significant liquidity from individual investors' cash (or, as suggested by other observers, by net buying by private 401(k) and similar pension plans). We hypothecate that at least some stock market liquidity, and the resulting higher prices, was supplied by hedge funds, who may have increased their bets that stocks will rise (by shifting to becoming more long-biased). If stock-price levels continue to rise in 2010 due to improving economic and employment conditions, individual investors should start to add to their stock fund positions and thus contribute liquidity to the stock markets too.


As suggested below, net inflows to bond mutual funds have been significant in 2009. Contrastingly, net inflows to stock funds, rebounding some during the spring and summer after the stock market trough in March, have moderated since and were slightly negative in many recent weeks. Ambivalence about the too-quick increase in stock prices, some "get near even and then get out" withdrawals, and uncertainties about employment and real-estate wealth have combined for the slowdown in net flows of cash to stock funds (despite some pickup in mid-December, though).



Looking ahead to the coming year, a  number of developments are needed for renewed stock-fund purchasing and net inflows. First, more time must pass since the financial market trough; each crisis is difference, but I estimate that 12-18 months need to pass for many investors to re-engage in a meaningful way. Second, we need to see positive indications, such as interest rate hikes from the Federal Reserve, that the economy is heading upward, and signs of progress (instead of limbo) in Washington.


Assuming positive economic developments unfold this year, Strategic Insight's Forecast for 2010 projects stock-fund purchasing activity to increase by 20% this year - after falling by nearly 25% during 2009. [Find out more about our forecast report here: http://www.sionline.com/published/2009-whitepapers/main.asp ] Gains by international funds and balanced-type funds are projected to be above average while sales increases of US stock funds might lag. 

Personally, though, I am still mulling over Mr. Buffet's conviction that one shouldn't bet against America. Maybe he meant not to bet against the many ideas of America that led to his own success: entrepreneurship, innovation, self-determination, and optimism. Today, these many ideas are behind the fast-growing economies worldwide and especially in some of the Emerging and Frontier Markets.


And, tracking stock mutual fund purchasing activity as we do at Strategic Insight, I realize I am not alone in searching for signs of renewed stock-market confidence. I am joined by many of the 50 million American households - some living in towns like Warren Buffet's Omaha - still hesitant to add to their stock mutual fund holdings. Yet we all hope over time to invest in such funds to build wealth for retirement, for our children's educations, or for travels to the many places around the world starting to look like New York or Chicago - places even more crowded with optimists who invest in entrepreneurship, innovation, and self-determination.


Missed Part 1?
Planning for 2010, I:
Tectonic Plate Shifts and the Insatiable Demand for Bond Funds