Equity fund flows are very very pessimistic at the current time. Globally, investors have been exiting the equity market and chasing defensive assets with yield, like government or corporate bonds. It seems that everyones favourite group of "experts", financial advisors, are now running around circles recommending mums and dads to take money out of the stock market and place it into a more "safe" bond investment.
According to Nomura's recent research (chart below), cross board equity fund flows for the US, Europe and Japan are now at the second lowest level in over two and half decades. The only time investors were more negative was during the once in a generation 2008 crash - and we haven't seen one of those since 1974 or 1932 prior to that. I actually found the whole thing so astounding after I noticed that outflows today are relatively worse than back in 1987, when the stock market globally crashed between 40% to 60%. Boy, are people scared to death of losing money in stocks!
On top of that, contrarian investors should note that every crisis brings about a buying opportunity, which is shown very well in the chart above. This is something mums and dads, and their financial advisors are yet to figure out. Be it the Gulf War in 91, Mexican currency devaluation of 95, Asian financial crisis of 97, Russian bankruptcy of 98, 9/11 terrorist attacks or the Enron & World.com scandals of early 2000s - all of these events create buying opportunities for strong returns going forward next 6 to 12 month. In other words, being a contrarian against the flow of funds and the flow of bad news usually pays returns. I guess I can say that is quite a smarter thing to do than herd into bonds and any other safe haven assets - which seems to be the most popular investment right now.
Fund flows to the ever popular Global Emerging Markets (GEM) have slowed down remarkably over the last 12 months as well. The BRIC fairy tale stories of strong economic growth are not working on investors right now as they are replaced by fear stories of high inflation rates and Chinese property crash. The chart above, once again thanks to Nomura research, shows relative equity returns vs Developed Markets and overlapped by mutual fund flows, which are than forwarded by 12 months to predicted future returns. The correlation between fund flows and forward returns stands at negative 71% since 1995.
In plain English these two indicators move in opposite directions, so the higher the inflows and optimism, the worse the performance and visa versa. The chart above shows that we are approaching an inflection point at which point GEMs should start outperforming the rest of the world. Funnily enough, just as we arrive at the point where investors should look for potential opportunities in this area, majority of global investors have been withdrawing money in an almost panic like fashion. While we are not yet at 12 month rolling average of outflows, we are definitely close to it. Keep an eye out on GEMs, because if they do fall hard one more time, do not hesitate to jump in with both feet. You will be a lot richer 12 months after!
Finally, lets look at the short to medium term picture in chart above. We are looking at domestic mutual fund flows. It is safe to conclude that mums and dads have been exiting the equity market in a hurry in the US, especially since the peak in early May 2011. As a matter of fact, we have seen 8 monthly outflows from the equity market this year, out of the possible 11 months. Even more importantly we have had some serious money leaving including a $30 billion outflow in August during the market crash.
I think it is safe to say that retail investors are completely scared the hell out of the equity market, mainly due to the insane volatility and also due to the consistently negative and fearful news flow that seems to bombard them on daily basis. I can now assume that it will be a long while until we actually see a proper monthly inflow, let alone two in the row - sounds like a wall of worry to me...