What inflation is not, we believe, is "too many dollars chasing too few goods." Pure and simple, it is "too many dollars." What the redundant dollars chase is unpredictable. - James Grant
It seems as though there has been a large shift in the perceptions of market participants of late. People are taking their hard earned dollars out of the popular stock and bond markets. Where are they then putting these dollars? This is an interesting question which we try to answer in this article.
With more bad financial news from Europe and concerns about conflicts in North Korea and Iran, Americans are more and more seeking safety in their investment portfolios and are less accepting of market risk.
Stocks
An analysis of the September 2010 Morningstar Fund Flows report shows that investors put money into international stocks, though not as much as they took out of the US stock market.
The report goes on to say that investors have pulled $80.9 billion from U.S. stock funds over the trailing 12 months, while adding nearly $34.3 billion to international-stock funds.
In addition, investors put 64.9 billion into ETF funds from September 2009 to September 2010. Most of this investment went into high dividend ETFs, as investors clamor for yield.
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Insiders have been selling more than buying for quite some time, leading to an 8000 to 1 sell to buy ratio last week. Insiders, who know most about the stocks they represent, have been bearish for quite some time.
What about retail fund investors? Flows out of equity mutual funds have occured for 29 consecutive weeks, with last weeks' surging to .8 billion. It seems mom and pop don't feel so bullish about the American stock market anymore.
Marketwatch is reporting that the Spanish stock market is getting hammered amid concerns Portugal and Spain will be the next bailout targets.
Debt
Municipal bonds suffered an outflow of .78 billion last week. According to Brian Reid, Chief Economist of ICI:
When you see falling bond prices and falling bond-fund returns, it's not unusual to see some outflows from bond funds.
That makes sense. Rising interest rates on bond issues cause people to leave a less valuable (read:more risky) investment class.
Tom Roseen, a senior analyst at Lipper, believes a looming potential tax cut extension from a Republican House makes muni's less attractive because they are exempt from Federal Taxes. While this could be true, how would that explain the previous run of inflows during which lower taxes were in force? In other words, since nothing changed from the time investors began putting money into muni bonds, and tax cuts are not a given with a gridlocked congress, this doesn't seem a likely cause for sudden change in market mood.
In reality, this is still a drop in the bucket of overall investments in muni bonds, so we cannot call a true market sea change until we get a month or two of data. But the reversal is still interesting ...
How does the movement in muni's affect other bond classes? We turn to Greg Peters, global head of fixed income and economic research at Morgan Stanley.
The recent moves in municipal yields could be a potential harbinger of things to come in other bond markets. Retail got out very quickly, and because retail investors have put so much money in all types of bonds in the past 18 months, these markets are more sensitive to retail behaviour than ever before.
Long bonds have been retracing to support levels as people increasingly fear higher interest rates due to price inflation or inflation brought on by economic recovery (the latter which I think is impossible for the US until employment brightens). While the greater bond market is in a bull run, it appears as though investor sentiment is cooling on domestic debt.
Right now Fed buybacks are keeping Treasury notes and bonds propped up.
Investments in East Asian bonds increased during the third quarter to .1 trillion likely due to positive growth outlook in the region.
Treasury bill auctions bring negative yield as investors correctly assume Bernanke will be successful in creating inflation. While I feel that the bet is correct, government gimmicking of inflation statistics will keep official inflation measures muted and TIPS investors are likely to be disappointed with the end results. And as the above Morningstar Fund Flows report highlights, over billion was taken out of TIPS between March and September 2010.
Two articles emerged recently regarding European debt markets. Ireland's debt crisis has forced Portugal and Spain's borrowing costs to record highs.
Credit default swaps (CDS) measuring risk on German, French and Dutch bonds have surged over recent days, rising significantly above the levels of non-EMU states in Scandinavia.
European markets are seeing spillover from Greek and Irish debt problems. This threatens the base of the European debt market and will affect investor sentiment moving forward. After Europe plays out, similar fears will strengthen in America.
Money Market Funds
Money Market Funds had net inflows in the last week.
In a separate weekly report, the ICI reported that assets in money-market funds grew .36 billion in the latest week as nearly all fund categories reported inflows, with institutional funds seeing the larger net gains.
Investors are seeking 'safe' investments with short maturities while avoiding long term interest rate risk of longer maturity debt.
This is a reversal of previous months as a bit of fear behavior emerges in the market. Investors are seeking dividends, safety of principal, and shunning interest rate risk.
Commodities
Morningstar notes that .5 billion was moved into commodity funds September to September, continuing a trend started in January 2009. Precious metals funds took in less than the broad basket of commodities funds for the year, but precious metals returned 3x returns of non-metal commodity funds during that time frame. Investors missed a lot of return here. But apparently they are catching up as the precious metals funds surpassed other commodity funds in September.
GLD has seen large inflows this year.
Physical Gold and Silver
Physical gold sales are up domestically. US Mint Proof Gold sales were million in October, compared with 0 million from the entire previous fiscal year.
The Mint has sold 1,046,500 1 oz gold Eagles, 43,000 1/2 oz Eagles, 58,000 1/4 ounce gold Eagles, and 385,000 1/10 oz gold Eagles. In addition, the mint has sold 72,498 proof gold Eagles of various sizes.
The US Mint has sold 32.4 million silver American Eagles this year, and 273,000 silver proof Eagles.
Trends
While investors are seeing more risk and consequently moving out of the stock and debt markets, there is clearly a lot of money that can move into alternative investments should more bad news emerge. If, for instance, the European Union continues to show strain upon failed bailouts, investment into commodity stocks and physical precious metals will increase. Given concerns about American debt, I am not sure Treasuries will be thought of as good long term investments as they have traditionally been.
