Big Picture: Follow the Money
By Gus Krafve
May 6th, 2008
Investors have been selling equities in exceptionally large amounts. For the third and fourth quarters of 2007, investors sold a net $390 billion. On the flip side, corporations bought back a similar amount of stock. The exit from the US market is on par with two previous periods, second quarter 1984 and second quarter 1988. On each occasion, stocks rallied over the subsequent twelve months by 25% and 27% respectively. These trends in the US have been mirrored on a global basis where the rush to get out of the equity market has been unparalleled both in terms of its absolute size and in relation to market capitalization.
So, where has the money gone? The answer is clear - into cash and especially money market funds. Net inflows into money market funds from US investors have amounted to over $500 billion in the past two quarters. Total US money market fund assets are nearly $3.5 trillion, and relative to the market, we are at levels not seen since previous stock market lows of 2003 and 1982. High levels of cash tend to be bullish indicators for the future direction of the stock market. As investors’ sentiment turns more positive, they tend to liquidate money markets and invest in stocks.
On a sector level, money continues to flow into Energy stocks and away from Health Care and Technology. The chart to the right breaks down the percentage of assets devoted to each sector through exchange traded funds (ETF’s) and other sector funds. For example, if we look at the amount of cash invested in sector funds and ETF’s, 22.9% is currently invested in the Energy sector. The data, compiled by research firm Ned Davis, has been tracked since 1989. The percentage in parenthesis is the historic mean invested in each sector since 1989. Energy has only garnered an average of 9.4% of all sector investments since then. Conversely, Health Care, Technology and Telecom are significantly under-owned versus their 20 year average. Investors currently only have roughly half of the dollars allocated to those sectors versus their mean. The most surprising is the Financial sector. Despite all of the turmoil in the sector and the fact that it was down over 20% in 2007, nearly 20% of all sector fund assets are allocated to Financials versus a historic average of 13.4%.
We know that sectors go in and out of favor with investors; how can we forget about the technology bubble? Currently, Energy is the most over-owned sector and thus, has the most risk to the downside if fundamentals in the sector deteriorate. Conversely, Health Care and Technology appear as though they don’t have significant relative downside risk at this point. And, if the fundamentals improve, these growth-oriented sectors have a high probability of outperforming the market.
