New Cash Into Funds Broke Records in January! But...

Yes, a record gush of cash flowed into mutual funds in January, but because most of these greenbacks went into money market funds, the record isn't something to shout about.

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Flows to mutual funds topped $140 billion last month, according to Thursday releases from New York-based fund consultancy Strategic Insight and Summit, N.J.-based fund tracker Lipper. (The firm's figures varied slightly.) For perspective, this inflow shattered the previous record of $86.9 billion set exactly two years earlier, according to the Investment Company Institute, the mutual fund industry's trade group. Record fund flows are typically great news for the stock market because rising fund flows indicate bullishness among investors and often presage a rise in stock buying and stock prices. But because more than 70% of this cash went into money market or cash funds and much of the stock-fund flows went to more conservative funds, the record isn't as compelling as it sounds.

"I wouldn't even use the $140 [billion] figure because it's misleading," says Charles Biderman, president of liquidity tracker TrimTabs.com. "Whenever short-term rates drop [as they did in January], institutions put money into money markets because their rates lag for 30 or 60 days. That's just people looking for a higher yield for a few weeks, not people saying they want to be in or out of the market."

Of the $141.1 billion -- according to Lipper's numbers -- that found its way into funds last month, $99 billion went into money market funds, $33.5 billion went into stock funds and $8.6 billion into bond funds. Institutional investors accounted for some $70 billion of the flows to money market funds.

Now, pundits are going to run with these numbers in different directions and may arrive at varied conclusions, so let's take a closer look and draw our own, shall we?

We're in the Money January inflows to money market, stock and bond funds (in billions of dollars)

Source: Lipper.

Beyond money market investments triggered by the rate cut, the money market flows had another seasonal boost. Flow records are often set in January because that's when some companies make their quarterly and annual matching contributions to their employee's retirement plans. It's also when many individual investors fund their individual retirement accounts or IRAs with year-end bonuses to reduce their tax bill. Before moving into stock or bond funds, this money often goes to money market funds.

That said, flows to stock funds were the highest they'd been in recent memory. That may have helped the S&P 500 and Nasdaq Composite post January gains of 3.5% and 12.2%, respectively, according to Baseline/Thomson Financial.

"A good deal of the flows were due to the seasonality of 401(k) contributions, and a lot of people are doing the IRA stuff," says Lipper senior analyst Don Cassidy. "Still, the equity numbers were the best since April, and it equaled all of the fourth quarter's inflows, not that they were anything to write home about." The record for one-month inflows to stock funds is $55.2 billion, set 12 months ago, according to ICI data.

The cash flows among stock funds highlight a tectonic shift in investor sentiment. For the past few years investors have been primarily buying shares of growth funds, whose taste for pricier stocks in the tech sector helped them outperform value funds, Wall Street's bargain hunters. Growth funds still took outsold value funds, $11.8 billion to $7.7 billion, according to Lipper. But value funds' inflows were the highest they'd been in three years, according to Strategic Insight.

Growth Still Growing January inflows to growth, blend and value funds (in billions of dollars)

Source: Lipper.

And balanced funds, conservative funds that blend stock and bond investments, took in $1.7 billion, compared with just $500 million for all sector funds, which drew 33% of net fund flows last year.

"I think the breakdown of stock fund flows is an indication that people aren't feeling too confident," says Lipper's Cassidy. "The fact that value funds grabbed a lot says that, as does $1.7 billion going into balanced funds. Sector funds with almost no net flows shows that people's self-confidence is down."

Rising cash flows to fixed-income funds illustrates more of the same. It seems many investors, burned by last year's Nasdaq meltdown, sought the relative safety of bond mutual funds. For the first time in more than a year, all bond-fund maturity classifications saw positive net inflows, according to Lipper. Interestingly, high-yield bond funds, which lead all U.S. stock and bond fund categories with a 6.8% average gain this year, took in some $4.4 billion in January. That adds up to half of bond funds' inflows.

The intriguing question, of course, is where do we go from here -- now that we're past this seasonal bump in cash flows and the markets have turned rocky. So far this month the S&P 500 is down 8.1% and the Nasdaq Composite is off more than 18%. Biderman says early estimates indicate that stock-fund flows are slowing down again.

"January is usually a strong month and the market did well, so people put money into equity funds. This month the market is sloppy, and we're seeing about a net zero. Flows will follow performance, and they always have."

If flows and stock market performance are a chicken-or-the-egg proposition, then maybe those folks who called this a stock picker's year where only fundamentals would drive stock prices were right on the money. In any event, 1999 seems like a lot more than two years ago.