Big net inflows to fixed-income and global-equity-strategy mutual funds are just the latest example of investors moving in the wrong direction at the wrong time, leading financial advisers and market watchers contend.
“You have people chasing yesterday's returns, and, to the extent there is significant risk right now, I think it's in the bond market, not the stock market,” said Harold Evensky, president and principal of Evensky & Katz LLC, a $700 million advisory firm.
“The risk is in bonds, because rates won't stay at these levels forever,” he said. “If Europe implodes, we're all in trouble, but long-term, five or 10 years or longer, markets go up and stocks earn more than bonds.”
Investors are moving out of domestic-equity funds just as stocks are moving into value range, according to Paul Schatz, president of Heritage Capital LLC.
“On many metrics, including [price-earnings] and stock-to-bond yields, the market is cheap, but there's a value trap, because cheap can get cheaper,” he said.
With the forward P-E of the S&P 500 at about 10.5, compared with a historical average of 15, some advisers such as Mr. Schatz think that the “dark period” in the market is about to end.
“Right now, earnings are close to record highs, but stocks are nowhere near records, because P-E ratios are compressing,” he said. “But that trend only continues for so long, because a P-E below 10 is a screaming "buy.'”
Although some analysts dismiss forward P-E data because they involve projections, the S&P 500's P-E of 12.5 is relatively attractive, especially compared with a trailing-four-quarter P-E of 16.
“What we're seeing now is a traditional pattern of a herd mentality by investors,” said Matthew Lloyd, chief investment strategist at Advisors Asset Management LLC, a $7.2 billion advisory firm.
He pointed out that the S&P 500's 2.2%
dividend yield is better than that of the 10-year Treasury, which should be an argument for owning equities.
“We consider Treasuries rewardless risk,” Mr. Lloyd said. “The real value is the equity portion of risk assets.”
CASH FLOW ADVANTAGE
Cash flow multiples also favor stocks, he said, pointing out that the S&P 500 is trading at seven times per-share cash flow. By comparison, the average over the past 15 years is 12 times cash flow.
On a price-to-book-value basis, the index is trading at 1.9 times, which compares with an average over the past decade of 2.5 times book value.
A reversion to historical averages for just those three metrics would have the index gaining between 24% and 63% at fair value.
“It shows the amount of value that's out there right now,” Mr. Lloyd said.
Equity funds overall have experienced $84 billion worth of net outflows this year through October, while bond funds have had net inflows of $100 billion, according to the Investment Company Institute.
The direction of the fund flows suggests a third consecutive year of net outflows from equity funds.
Bond funds, meanwhile, have been enjoying annual net inflows since 2005.
This year, the pace is being set by the $61.2 billion Templeton Global Bond Fund (TPINX), which had $15.2 billion in net inflows through October.
The five-star-rated fund was down 4.3% through Nov. 28, ranking it in the 98th percentile of Morningstar Inc.'s world bond category, which had an average return of 1.9% over the period.
Another investor favorite has been the $57.3 billion Vanguard Total International Stock Index (VGTSX), which has had $11.7 billion in net inflows and declined by 16.7% so far this year.
The fund ranks in the 64th percentile of the foreign-large-blend category, which averaged a decline of 0.5% this year.
“Given the overall market volatility, the uncertainty in Europe and the continued economic slowdown, it's not surprising that investors are more risk-conscious,” said Todd Rosenbluth, a mutual fund analyst at S&P Capital IQ, a unit of Standard & Poor's. “Investors have spent much of the year moving out of equities because they are more nervous, and that's why they're favoring higher-yielding dividend stocks, and higher-yielding bonds, where they can sit and wait.”
But sitting and waiting in yesterday's winners is a loser's game, according to Theodore Feight, owner of Creative Financial Design.
Following the contrarian route of going against the grain of retail investors — as illustrated by mutual fund investment flow — Mr. Feight plans to deploy one-third of his assets to higher-yielding corporate bonds, one-third to domestic equity indexes and one-third to individual dividend-paying stocks.
“I think we're going to get a Christmas rally, and I want to be a part of it,” he said.
Morningstar fund analyst Kevin McDevitt agrees that there is a case to be made for taking a look at the fund investment flow data skeptically.
"TWO EXTREMES'
Emerging-markets funds, for example, which have declined as a category by 20.4% this year, have had net inflows of $18.7 billion.
That compares with just $12.8 billion of net inflows for all international equity funds, which include emerging-markets funds.
“You've got two extremes at work here,” Mr. McDevitt said. “There have been strong flows into emerging-markets funds, even though they've had a rough year, but the emerging-markets story has been a strong narrative.”
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“The risk is in bonds because rates won't stay at these levels forever.”
Harold Evensky
President and principal
Evensky & Katz
