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What Cliff?

The American investor is an interesting subject for study. Since the market collapse of 2008, investors have been running from stocks to bonds. Fund flows have been largely to bond funds during this period. In fact, flows into stock funds reversed and have been outflows.

Some observers argue that, as the Baby Boomers reach retirement, it makes sense for interest in stocks to wane and bond funds to benefit. This makes little sense to me. A person born at the beginning of the Baby Boom is 66 years young. She should expect to live on average 20 more years, and could live much longer. Bonds have been a much worse investment over past 20-year periods than stocks. The other end of the boomer population is 48 years old. They are not retiring soon, nor are they ready to die. Why would they put their money in bonds? So the Baby Boomer argument makes little sense.

Meanwhile, since 2008 stocks have done little but rise. In 2009 stocks returned 26%, followed by 15% in 2010, a paltry 2% in 2011, and 16% in 2012. All together, a 72% return for these four years--not bad for all the trouble we've had. 2013 is starting off well, with more than a 3% return in the first half month. As investors tend to be lemmings and momentum followers, why do we see funds flowing out of stocks at the same time as we see the stock market rising? Pricing theory would have stock prices falling if investors are selling more than buying. Why are stock prices rising if investors are selling? Clearly, the mutual funds flow data does not account for everything.

I asked a couple of colleagues what they thought caused this conundrum. Their thoughts are: first, measuring only mutual funds does not cover all investments into or out of the stock market; and second, prices may have risen from a revaluation rather than a demand surge. These guesses make sense. At Regions Investment Management we mostly deal in individual securities rather than mutual funds. Also, with the exception of 401-k's, most large retirement plans have individual stocks and bonds with some mutual funds. Additionally, there has been a big increase in corporations buying in their own stock. These purchases of stocks would not be picked up in a review of mutual funds.

Magic is the art of making your eyes see something unreal. The mutual fund survey is telling us that investors are leaving the stock market and buying bonds. The stock market is telling us that there are more buyers of stocks than sellers. I am going to bet on the latter. Prices could not rise for four years in a row without buyers' support, whether from institutions, corporations or individuals. Therefore, I conclude that investors as a whole are optimistic about the future, not overly worried about the debt crisis, and not too worried about the cliff. Cliff? What Cliff? You mean all that hubbub in Washington a couple of weeks ago? It's just noise-- don't pay any attention.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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