Wednesday, 30 December 2009

Chart of the Week – Bond Mutual Fund Flows

I often write about the US stock market for a number of reasons. I have been a professional investor investing in that market. The US market is the largest and most developed in the world. The US stock market usually sets the tone and the pace for other markets – correlations are very high between other equity markets and the US equity market. The expression "if New York sneezes London catches a cold" is a truism that could be applied to most markets. Since the globalisation of US portfolio flows first by Capital International and Fidelity and then by US hedge funds the sectoral out and under -performance within stock markets have become global phenomena. Plus the ready availability of data and a long history of data collection and analysis allow investors to use tools based on American market phenomena that should work elsewhere, but if not the market-level call will still prevail. So looking at and analysing the American stockmarket is looking at the world of equities on a week-to-week or month-to-month basis.

I often have a "fact of the week" and "chart of the week". This week's chart is below and comes courtesy of Citigroup's research. It shows US mutual fund flows over the last five years.

This year the stock market has been about bear psychology in the first quarter, and since then about liquidity. I believe in Marshallian K, so to me the rally was mostly explicable by the enormous money creation and liquidity creation we saw in the last 18 months being channelled into financial assets because the real economy could only use it up with a lag. The US economy has started to grow, so towards the end of the year the rate of gain in stocks tailed off, as the real economy started to use the money that was created a year ago.

So having a rally in 2009 was not a surprise. The scale of the rally did surprise me but should not have done – the historical precedent of the Great Crash had an analogous rally – also a 50% retracement, and up around 50% from the low. One of the reasons that I thought that the rally might be significantly smaller was the psychology of investors. The Coppock indicator is based on recovery from trauma. In my mind the Coppock indicator is of limited use. Indeed it is only useful for non-professional investors – it is lagging and confirms only buy signals, but does tell long-term investors that a market is safe. The Coppock indicator is based on 11 and 14 month moving averages. I has assumed that we would have a limited recovery because it just takes longer than a few months to get over the trauma of what happened in the 2H of 2008. It turned out that the balancing item of liquidity provision was so huge that it overwhelmed the psychological imperative in 2009.

I think the chart of US mutual fund flows from the Investment Company Institute tells us a lot about the state of psychology of the US individual investor, and to some extent about the psychology of all investors in equities. We are still very much in the mode of "it is the return of my money that is important rather than the return on my money". I first heard the expression that "cash was trash" in the early '90s. At that point a bull market was still in gear, the bail-out of S&L s had taken place and returns on cash were derisory by the standard of recent decades. There was a compulsion to put money into stocks and other financial assets because there was nowhere else to go. The events of 2008, and the money market fund scandals, and the level of trust in banks all reinforce staying out of money market funds and other cash proxies to a degree. Sales of domestic equity mutual funds have been minimal this year. The positive flows to equities such as they were went into overseas equity mutual funds, as if Main Street didn't want to give its money to Wall Street. Almost by default US mutual fund investors have moved out on the steep yield curve and bought bond funds. Over the last 18 months more money has been put into bond funds than was taken out of US equity mutual funds.

So the current state of psychology of US investors is keep me out of Wall Street, I want the return of my cash, and I can only trust Uncle Sam with my money at the moment, thank you.

The equity market low was mid-March 2009. Eleven months on from there is February 2010. If the trauma of the Credit Crunch of 2008 is mitigated in the period around March-to-May 2010, where will US and other investors put their capital then? Cash will still be trash: even if the Fed raise rates it won't be by much. So a big question for next year, maybe even THE big question for next year is whither inflation, government borrowings and bond yields?

Two prominent hedge fund managers are making big bets on U.S. Treasury yields.

John Paulson’s Paulson & Co. has begun shorting U.S. government bonds, believing that inflation will lead to higher yields, which will drive down the price of the securities, the Financial Times reports. “It will be difficult for the government to withdraw the economic stimulus,” Paulson said in a recent speech. “An increase in the monetary base leads to an increase in the money supply, which leads to inflation.” According to the FT, another major hedge fund, TPG-Axon Capital Management, is also betting on rising yields.


  1. This looks freakling awesome post!...All the graphical explaination about fund bond themes is very nice presentation...Keep this great job....