Although there are some who continue to worry that the Fed's massive liquidity programs will ignite consumer inflation, I continue to view this as a very low risk. Consumers just aren't spending enough. But that isn't to say that the current level of money growth can't have serious consequences. Instead of excess liquidity flowing into consumer spending, it could flow into the capital markets, creating new distortions.
Today, as the 10-year Treasury is hitting 3.29% at the same time the Dow hitting new year-long highs, you have to ask, where is all this investment demand coming from? Is it a bubble? Maybe we don't have too many dollars chasing too few goods, but maybe we do have too many dollars chasing too few investments.
But here is an interesting caveat. The chart below shows mutual fund flows for the last three years. 2009 is YTD with no adjustment. Bonds are blue, stocks are yellow and "hybrid" funds are green.
In 2007, we had total flows of $223 billion, 41% of which went to equity funds. Then we have the panic year of 2008. Investors pull $226 billion from mutual funds, all most all of which comes from equities. It looks from this chart as though retail investors pulled money from stock funds and left the proceeds in cash, thus creating the much ballyhooed mountain of cash. But the month-by-month flows tell a different story.
Here we see fund flows month-by-month among bond fund types. For the first 9-months of 2008, there was a healthy $90 billion flow into bond funds in total. That's slightly ahead of the $108 billion pace of 2007. But in the last 3 months, investors pulled $63 billion from bond funds, adding to their cash hoard.
Now on to 2009. So far this year investors have added virtually nothing to equity funds. There is no mania there, at least not when it comes to retail mutual fund investors. Now there is significant variation month-by-month. In the first three months of 2009, investors withdrew $40 billion only to add $53 billion since. But even there, it doesn't look like a mania at all. Over the last 6 weeks, there have been $4 billion in net redemptions. Even the $53 in net purchases over the last 6-months seems paltry compared with the $233 billion in redemptions last year.
By contrast, take a look at bond funds. Fund investors have made net purchases to the tune of $253 billion so far this year. That is just about double the last two years of net purchases combined.
And unlike stocks, bond investors don't have any need to "catch up." If anything, mutual fund investors would seem to have come into 2009 over weighted in bonds. Not only did mutual fund investors redeem $233 billion in equity funds in 2008, those same funds plunged in market value during the year. If retail investors followed any kind of rebalancing discipline (no laughing back there anyone who deals with retail investors... I said "if"), there would be the need to redeem bond funds and buy stock funds. Right now the opposite is happening.
So it makes one wonder. If there is a bubble, isn't it more likely in bonds? If there is an asset class that is getting more than its fair share of the excess liquidity, it isn't stocks. Its debt.
15 comments:
Thanks. I see different flow data for this year on the ICI site but the point you make is visible in their data as well:
http://www.ici.org/research/stats/trends/trends_07_09
Any chance you could supply a data source?
Any sector allocation by bonds?
Corp, high yield, emerging market govt, munis? Which sector is experiencing the most inflow? The least?
Here is more coverage on the bond story from an earlier time:
http://www.ritholtz.com/blog/2009/
09/watch-bond-fund-flows-not-stock-
fund-flows/
I have never watched the 10 year yield fall and the Dow surge at the same time. If this were normal times, the market would be telling me to short equities with both fists.
But these are not normal times.
PS. WSJ article out today that promises $35 billion for ADDITIONAL housing loans. How does that impact your analysis of the RMBS market post earlier last week?
http://online.wsj.com/article/
SB125409967771945213.html
http://www.bloomberg.com/apps/news?pid=20601109&sid=aCgGPmSKDjnw
did you catch this? seems to support your position
Hi Al,
Good article. I agree with 80% of it. As I noted a couple posts back I think the US bond market in general is overpriced. I think the worst aspect is in government bonds (both Treasuries and munis. But even corporate seems pricey right now.
Where I respectfully disagree with you is (of course) on the inflation issue. I DO AGREE that in the short to intermediate term the danger of a sharp spike in the CPI seems pretty low for the reasons you outlined. But in the long term this won't last.
We are debasing our currency and people (including me)are starting to take their dollars and invest them outside the United States. More money means inflation. It may take time (in some cases years) for that to start being felt. But it is coming unless the US Gov't starts to radically change its ways.
People often say that we printed money during the Great Depression and World War II without causing inflation. But that is not true. We did create inflation. The effects of that inflation were simply kept in check for a while by the exigent circumstances (high unemployment and later war time rationing). But immediately after the war the inflation chickens came home to roost.
I simply have no confidence in the FED's ability to stand up and do what Paul Volker had the intestinal fortitude to do. Volker plunged the US into a mini depression in order to save its currency. We need to do that again. But does anyone really think helicopter Ben is ready or able to do that?
As a side note I also have zero confidence in Congress's ability to deeply cut spending and raise taxes sharply, both of which we need to do. I won't even discuss Obama. So how long before we get slammed by all of this monopoly money? I doubt anytime before 2011 (though I hasten to add I could be wrong). But I do see the dollar's death by a thousand cuts resuming in the near future after its brief rally.
In the meantime I think US bonds are a sell. The potential upside is minimal. And the potential downside is steep. Buy foreign. The risk reward ratio is far more attractive.
Much of the recent NYSE volume is concentrated in 5 most active stocks. This usualy includes companies with fed bailouts. Could this be just the fed driving up the market volume for investor confidence building. A 1/3rd reduction in NYSE volume would drive away investors and could spiral downards along with stock prices due to lower and lower demand.
Long-time reader, first-time poster. I don't know if bonds are over-priced or under-priced but I have a different view on why bond inflows have been so strong this year. Boomers have basically gone through the last 10 years with negative or minimal returns from equities. As was taught to the average person during the tech boom, equities are the place to invest for retirement and they have 70+ years of going up. Joe-6-pack is stubborn and rode out the tech boom only to get caught back up in the global liquidity fallacy that crashed in 2008. I believe that many boomers were heavily tilted towards equities over the last 10 years but after being burned twice, they are finally (finally) taking this asset allocation stuff seriously. I believe many boomers realize that equities are riskier than they can handle and they will need income sooner rather than later, thus the massive bond flows this year.
Anecdotally, my parents, my partner's parents, and numerous older American co-workers of mine (55+), have also been putting pressure on their financial advisors to de-risk. This tells me that maybe financial planners and advisors were feeling some heat from their performances over the last few years and have been steering their clients towards something (supposedly) safer and less volatile as well.
Great post. Let me add that in the longer run, buying debt and even equity (as investment) finds its way into the real economy. ie, you make a loan to a corporation, the corporation then does capex and increases production, etc. And on the investor side, the investor receives income, spends that income on production that resulted from increased capex from better investment. Furthermore, lower cost of capital helps increase corporate profit margins, resulting in higher descretionary income amongst agents within the economy. Just a few simple causalities like this connect the dots and remind us that 'consumption money' isn't isolated at all from 'investment money'.
Does your analysis factor in ETFs? Is there a comparable inflow / outflow metric available on them? My impression is that this latest big decline has again shown that actively managed mutual funds do not in general outperform index/sector ETFs. Could there be a structure shift to ETFs that is distorting the usual mutual fund / bond analysis?
i posted the following over at tradersnarrative:
first: i would agree that deleveraging and growing unemployment are contributing to outflows of equity funds.
second: don´t know the exact statistics (sure you will find them ;) ) but since american portfolios/401k have been heighly overweighted in equity funds, even a small rebalancing towards bonds should produce those diverging flows.
(according to http://www.usatoday.com/money/perfi/retirement/2009-09-23-investors-conservative-risk-stocks_N.htm
"A recent poll by the American Association of Individual Investors confirms that individuals are underinvested in stocks. Individuals had just 54% of their money invested in stocks at the end of August, below the long-term average of 60%.")
third: even after a 50% rallye people don´t see improvement in their own real everyday economy. those second derivative green shoots don´t matter when you see people around still losing jobs, income shrink, foreclosures, store closings, tight acces to credit…
average joe still doesn´t buy a real recovery. smart or dumb? well see soon.
fourth: as for the psychology you should simply talk to a banker/broker.
over here in germany i was working in a bank as a fincancial advisor from 1995-2004.
historically germans have been heavily UNDERweighted in stocks. that changed with the new economy/dot.com bubble.
after it burst many first time buyers and even hardcore long term holders have been burned. when the stock market recovered from 2002 interest in stocks was declining and even has been so throughout the recovery. when talking to customers in 2003/2004 nearly nobody was willing to bite on stocks. instead we were selling bond funds, funds with guarantees and newly engineered certificates which all had one thing in common: downside protection.
when the dax rose from a 2002 low of 2.800 to news highs above 8.000 in 2007 those customers looked like fools.
but right now they should feel pretty comfortable.
i guess for the way more experienced and relaxed american investor one boom/bust wasn´t enough to shake his decades long grown confidence in stocks. but that COULD have changed with the second crash within 8 years.
one more important point:
i´m pretty sure that a huge part of the inflows into corporate bond funds are due to the active advisory of bankers/brokers.
banks balance sheets are constrained, while (after months of disrupted capital markets) corporations are in heavy refinancing needs.
when looking at prospectus of new bonds you will find one thing very often: “the proceeds of this offering will be used to pay down bank credit lines”.
->banks are heavily transferring credit risk from their own books to the bond markets.
you can only do this, when you can created sufficient demand for this stuff…
i do think we´re experiencing a bank engineered bubble in corporate bonds, espcially in junk bonds.
but there´s lot of refinancing in the pipeline throughout 2014.
http://ftalphaville.ft.com/blog/2009/07/29/64406/a-european-lbo-legacy/
http://www.reuters.com/article/privateEquity/idUSN0325398120090803
so while i do agree that bond markets currently underprice risk, i expect this trend to continue.
Very interesting data--I agree with most people in the comments that the chief selling/buying point of bonds has been their "safety." Unfortunately, when buyers seek safety, they usually wind up with something else--not right now, necessarily, but sometime. After all, the stock market, for all its faults has a few advantages--its pricing is transparent and it is liquid (at least for small players like me.) The retail bond market is neither.
Anon 4:07: My data is from ICI, it just goes through September instead of stopping in July.
Debt: The only break out is taxable vs. munis. Taxable is getting more flows, but muni flows are strong relative to history.
As for bonds and "safety" the 5-year at 2.2% isn't very safe. Over five years inflation is bound to average over 2%. So at best, its a zero real return. Stocks are likely to outperform that considerably even given a decent correction which we are long overdue.
Retail is always last to the party!
AI - Been following for awhile - I love the blog, a friend turned me onto the site.
Great post, quick question, do you utilize in your accounts, or have an opinion on $TBT as a vehicle to trade/invest to back up your overall thesis?! I'm not buying now, but soon ....
I use TBT both from the long and short side to bet on rates. But it isn't a great long-term play due to problems with ETF math.
http://accruedint.blogspot.com/2009/05/leveraged-etf-math-this-may-smell-bad.html
Thanks for sharing these kinds of liquidity programs.
I found a great deal of useful material here!
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