July Records Biggest Inflows... Into Cash?

Submitted by Lance Roberts of Street Talk Live,

With the Federal Reserve's bond-buying, liquidity-injecting, market-inflating, volatility-suppressing, confidence-inspiring, economic-supporting, media-headline-generating, program currently in full swing; one would assume that the daily pushes to new market highs are driven by massive inflows of cash into the equity markets.   Well, that assumption would be partially correct.

According to Trim Tabs:

"Fund flows in the past two months were by far the most volatile we have ever measured. After ignoring equities and dumping bonds at a record pace in June, fund investors poured record sums into U.S. equities and continued to sell bonds in July."

Of course, this is clear evidence that the "Great Rotation" by investors, from bonds into equities, is upon us which will cause yields to rise as investors bet on a recovering U.S. economy.  Right?  Maybe not.

First of all there is scant evidence that the economy is entering into a growth mode.   Even after the recent data manipulations by the Bureau of Economic Analysis (BEA) to artificially inflate the economic data by $500 billion through the addition of pension deficits and R&D expenses; the annual growth rate of the economy remained below 2% for the third straight quarter.   Historically, such events have only been witnessed prior to the onset of economic recessions - not expansions.

Yet, the markets have continued to rise setting daily records with each minor uptick.  This incredible advance has come despite weak economic, and corporate, fundamentals.  The rush to plow money into equities since the end of 2012 has been quite astonishing as investors continue to show a complete lack of "fear" as evidenced by extremely low levels in volatility measures and record levels of leverage.  Historically, such combinations of complacency, exuberance and leverage have ended very poorly.

However, currently, there is no denying that the old Wall Street axiom of "Don't Fight The Fed" has been taken to heart.  The belief, by investors, is that as long as the Federal Reserve is intervening the "stocks" are the only game in town.  I recently showed the correlation between the stock market and the Fed's balance sheet expansions.

But, is it really the "Great Rotation?"  Have investors finally come to an agreement that the worst is behind us and a new secular economic and market cycle is just ahead?  While this idea is what we have been led to believe by countless pieces of hope filled  commentary - the real question is what are investors are really doing?

"According to Trim Tabs' research it appears that something quite different is actually occurring...more of the money that has come out of bonds is being held in cash rather than invested in the equity market.

In the eight weeks ended July 22, $110.9 billion went into savings deposits, while $32.5 billion entered into retail money market funds.

The combined inflow of $143.4 billion is almost triple the $54.1 billion that flowed into equity mutual funds and ETFs in June and July."

Trim Tabs goes on to state that:

"There is definitely a 'rotation' underway in the investment world, but it is premature to call it 'great,' and the 'rotation' is funneling more money into cash than equities.

Given the lofty valuation of the U.S. stock market, we cannot blame investors - particularly those with a long-term outlook - for favoring cash over stock. From a contrarian perspective, it is extremely bearish that so much money is pouring into U.S. equity ETFs,"

As I discussed recently in "Is It 'The Great Rotation' or 'Bad Behavior'":

"[Josh Brown] My argument was a very simple one...Capital does not chase value, it follows performance, and stocks had been winning for too long to continue to escape notice. Once the bonds started looking shaky, it had become a fait accompli...It's a shame they're coming in so late, but this is the nature of the beast."

"The reality, unfortunately for most investors, is summed up best by the last part of Josh's statement.  It is much more likely that the current 'rotation' of money from stocks into bonds is more likely a continuation of the bad investment behavior by retail investors rather than a secular shift in sentiment.

Retail investor's actions are driven by emotion rather than logic.  The chart above shows the investor psychology cycle of investment behavior overlaid against the S&P 500 index.  The bar graph in the chart is the 3-month average of net monthly inflows by retail investors into equity based mutual funds.  Not surprisingly, net equity inflows have turned positive at the peak of the market in 2011, just prior to the debt ceiling debate debacle, and the current QE driven asset inflation."

While investors are indeed most likely chasing performance of the market - they are also appear to being more "afraid" of the rally, that what we have seen historically, by storing more money in cash. 

As article after article has been written chastising investors for not "jumping into the market" - the reality is that investor "trust" has been broken.  They still remember being told that "this time was different" at the peak of the markets in 2000 and 2008.  It wasn't.

They also remember being told to "buy" and "hold on" all the way down during both market corrections that cost them 50%, or more, of their portfolios.

Now that individuals have finally gotten back to even, for the second time in the past decade - they are indeed taking rotating money in the markets - it just happens to be to cash.  But then again, after being lied to, abused, manipulated and defrauded by Wall Street - who can really blame them.