Kristina Hooper, CFP®, CIMA®, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
Investors are finally warming up to the stock market as corporate profits exceed estimates and the perils of so-called “risk-free assets” have become more palpable.
Stocks held fairly steady for the week. The Dow gave up some ground while the S&P 500 made modest strides. The biggest gains last week came from the small-cap space, with the Russell 2000 up more than 1%. Also of note was that the yield on the 10-year Treasury backed up to slightly above 2% while gold gave up almost 3.5% on the week.
It was a big week for earnings reports. Nearly 80% of the companies in the S&P 500 have reported fourth-quarter earnings. An estimated 72% of companies reported earnings above the mean estimate, which is slightly higher than the four-quarter average of 69% of companies beating earnings. However, when it comes to top-line growth, this quarter’s results have substantially exceeded the norm for the past year. A full 66% of companies have beaten their sales estimates, which is much higher than the 50% average for the past four quarters.
This is clearly encouraging for stock fundamentals. And with stocks up about 10% in the past few months, investors seem to be taking notice. We’re finally seeing significant investor flows into stock funds. US open-end equity funds gathered $20.8 billion in assets in January alone, after bleeding an average of $3.8 billion in 2012. And international stock funds, which had seen an average of $4.3 billion in monthly flows last year, experienced a dramatic increase in January of more than $34 billion in flows.
While many market observers are dubbing this shift the “great rotation” into equities from fixed income, a closer examination of fund flows tells a different story. Investors aren't selling bond funds to buy stock funds. They’re simply putting sidelined assets to work. Consider that in January the only asset class with negative net flows was money-market funds. In fact, open-end money-market funds lost $11.2 billion in January of 2013. That’s a significant reversal from 2012 when we saw an average net inflow of $144 million into money-market funds each month. Meanwhile, fixed income continues to be popular with investors: $40.7 billion was invested in open-end fixed-income funds in January, above the $30.7 billion average monthly flow in 2012.
This appears to be the beginning of a “great reversal” as investors are finally moving out on the risk spectrum. This makes sense given that the average investor is arguably overweight cash and cash equivalents. In fact, as of Jan. 31, 17.6% of all open-end fund assets are still sitting in cash and cash equivalents. This comes at a time when cash is not an attractive place to be. The current yield on the three-month T-bill is 0.101%. And if you think the nominal yield looks bad, consider the real yield on money market funds: with CPI at a still tame 1.77%, it is -1.669%.
But investors are not alone in suffering this “cash obesity” problem. Companies also have too much cash on their balance sheets at $1.1 trillion. They’re beginning to unwind these cash overweights and put them to work, with M&A activity at its highest level since 2005.
In this environment of financial repression, investors need to re-allocate to asset classes that offer positive real yields, protection from inflation and secular growth. Moving out of cash is the first step. It’s important to note that for investors moving into stocks, they need to have long time horizons and patience. Consider a statistic recently released by Morningstar: over the decade ended Dec. 31, value funds specializing in large stocks returned an average of 6.7% annually but the typical investor in those funds earned just 5.5% annually. The takeaway: Timing the market is a losing strategy. But staying invested for the long haul will help you capture the full upside and let time work in your favor.
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