Stocks Plunge Even as Fund Selling Fails to Materialize

It makes sense that gloomy types have predicted a crippling wave of redemptions by panicked fund investors in the wake of last Tuesday's terrorist attacks. After all, many have blamed sagging cash flows to stock funds for the market's losing streak all year.

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According to some widely held theories, stock sales by fund mangers are responsible for pushing already falling stock prices further down the hill. It's a tidy hypothesis, but a closer look shows plenty of cracks.

Though trading volume was heavy Monday and investors were flooding fund companies with phone calls, fund transactions weren't off the charts.

"Transactions are a bit higher than we might usually see, but they don't reflect a panic," says Steve Norwitz, a spokesman at T. Rowe Price. "We've had modest outflows from equity funds and modest inflows to money market and bond funds. What we're seeing today is far less of a reaction than what we saw [during the market crash] in 1987."

Representatives at Fidelity, Janus, Vanguard and American Funds -- five of the nation's seven-largest fund firms -- noted similar activity. Most reported higher than average call volumes early in the morning that dropped off as the day went on. Anecdotally, fund investors are asking about fund performance, fund holdings and their account balances, which haven't budged since stocks stopped trading last week.

"Call volume was high in the morning, but then came back down to normal levels," says John Demming, a spokesman at Vanguard. "Transaction activity is really minimal. We expect it to be close to normal business levels."

The bottom line: Fund investors are concerned about their money, but droves aren't necessarily voting with their feet, knocking the wind out of stock prices. In fact, the idea that lower inflows to stock funds kept gains low is more convenient than precise.

It's fair to say that investors have become reluctant to sock money into stock funds this year: The S&P 500 was off 26% and the Nasdaq Composite was down a jaw-dropping 58% over the past 12 months before today's losses. But stock funds on the whole have taken in $48 billion more than they've lost to redemptions. These seemingly conflicting facts are explained by the fact that stocks in mutual fund portfolios account for only a fifth of the U.S. stock market, with the rest held by individual investors, pension funds and insurance companies. All this makes it tough to give fund holders much blame for stocks' ongoing malaise.

"When you see stories on fund flows, they're written as if flows are this 200-pound gorilla in the market. They're not," says Russ Kinnel, director of fund research at Chicago fund-tracker Morningstar. "The bottom line is that funds flows don't drive the market in the short term and don't predict where it's going."

Researchers at the Federal Reserve reached the same conclusion in a December 2000 report, "Mutual Funds and the U.S. Equity Market." After comparing fund flows with stock price moves, they found "little evidence that mutual fund investors have been a destabilizing force in the U.S. equity market in recent years."

That's not to say fund flows aren't an intriguing metric. They do, for instance, starkly illustrate the eroding sense that one can make money from stock investments. Consider that in the first seven months of this year, net investments in stock funds shrank to $48 billion from $232 billion inflow in the same stretch last year, according to the Investment Company Institute, the fund industry's largest trade group.

At the same time, investors have sought shelter in safer ports such as savings accounts, which have taken in nearly $240 billion so far this year, and bond funds. The latter have taken in a net $45 billion in 2001, reversing year-ago net redemptions of $41 billion.

Liking the Mattress Fund investors are plunking their money in the bank, not the stock market
	2001	2000
Savings Accounts	$238	$75
Retail Money Market Funds	54	59
Stock Funds	48	231.8
Bond Funds	44.7	-40.5
Sources: Investment Company Institute and TrimTabs.com. Data covers Jan. through July 31 of 2000 and 2001.

In July, redemptions from stock funds outpaced investments by more than $1.2 billion, their third month of net outflows this year; before this year, stock funds hadn't seen outflows since 1998. While that is certainly a lot of money, there is some $3.6 trillion in stock funds' coffers. Given that the average stock fund has about 5.6% of its portfolio in cash, it would take several months of steeper outflows to send stocks significantly lower.

As usual, fund flows have followed performance. This is a perennial pattern; this year, that means money is predictably shifting into bond funds and tech-light value funds, both of which have held up far better than tech or tech-stuffed growth funds during the past year's tempest.

Do You Blame Them? The past year is among the dreariest in recent memory for stocks and stock funds
	1-Year Return
International Stock Funds	-29.3%
U.S. Stock Funds	-23.1
Municipal Bond Funds	8.9
Taxable Bond Funds	6.8
S&P 500	-27.2
Nasdaq Composite	-58
Sources: Morningstar and Baseline/Thomson Financial.

Naturally, some will stipulate that rising fund flows will buoy whatever segment of the market wins investors' attention and money. While a logical conclusion at first blush, it hasn't really happened. Last year, for instance, stock funds raked in a record $310 billion, but the S&P 500 and Nasdaq Composite lost 9% and 40%, respectively.

Fund Flows Don't Drive the Market It's hard to believe stock-fund flows drove 1999's gains because they didn't stave off 2000's losses
	Stock-Fund Inflows	S&P 500 Return	Nasdaq Composite Return
2000	$310	-9.1%	-39.6%
1999	188	21	85.6
1998	157	29	39.6
Sources: Investment Company Institute, Morningstar.

Some might wonder if the current outflows from many growth and tech funds will keep tech stocks down. But this ignores the reality that many of the value funds getting fresh money today are putting that cash to work in the battered tech sector, making it even tougher to claim that fund flows are part of the myriad causes that move stock prices.

"When the market is going up and money comes into funds, it helps the market, but it's not the [sole] cause of anything," says Charles Biderman, president of liquidity tracker TrimTabs.com.

The bottom line is that those hunting for stocks poised to rebound should focus more on the cash flows of companies and less on the cash flows of the funds that buy them.

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