Mad Dash to Nasdaq: How Fund Flows Feed the Fever Pitch

A rising stock market expands inflows to stock mutual funds. But what happens come January?
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Sure, some day tech's momentum move will end. For some reason or other, the highflying stocks that have dominated the market since October will run out of gas. And yes, it may end badly. Big deal.

But while that truth satisfies the first rule of financial advice -- tell them when or tell them what, but don't tell them both -- it doesn't satisfy much of anything else. Stocks' recent burst has defied even the most bullish observers' expectations; the widely expected pullback in major indices just hasn't come. Now, with money continuing to pour into equity mutual funds, people are saying the rally may continue, without pause, well into the first quarter.

Fund-flow dynamics have been a bit different this year, and that may account for part of the recent move. Typically, the first quarter is the strongest, then there's a sort of gradual decay -- first is best, second is next best, then third, then fourth. But this year, fourth-quarter inflows are running ahead of third-quarter levels.

Robbing Peter

"One huge question is, is the big fourth quarter making up for the weak third, or is it borrowing from the first?" says Doug Cliggott, equity strategist at

J.P. Morgan

.

Dash down some thoughts on our Nasdaq board

Probably a little of both. Third-quarter mutual fund flows were pretty abysmal: Only about $32.1 billion moved into equity funds, according to

Investment Company Institute

figures. This October, despite mild turbulence in the market, $20.44 billion came into funds, sharply up from last October's $2.4 billion.

And this makes sense. Conditioned by the action in the preceding two years, investors decided the third quarter was not the best time to put money to work. Moreover, people were a bit more worried then about possible Y2K problems than they seem to be now.

But it also seems possible that there won't be as much money on the sides to come into the market in January as in the last couple of years. The selloff this October was pretty muted: It didn't elicit the kind of runs for the exits that we saw in 1997 and 1998.

"What we might see is a little bit softer first quarter than normal," Cliggott says. "But it's probably still going to be positive. I wouldn't want to bet against a pretty good darn flow of funds in the first quarter, at least in January."

Paying Paul

January is always a big month for inflows, as year-end bonuses get plopped into 401(k)s. Moreover, market strength can create a sort of chicken-and-egg situation with flows. Stocks go up, money comes in. Money comes in, stocks go up. It's not infinitely sustainable, of course, but lately it's been pretty darn sustainable. Momentum trends usually don't die of their own weight.

"Flows will only slow when the market slows," says Bill Meehan, market analyst at

Cantor Fitzgerald

. "When you have a negative or poorly acting market, the flows reflect that." While he doesn't think what's going on is healthy, Meehan has been advising clients to join in on a ride he thinks will last at least until the

Fed

renews its tightening course -- which he doubts will happen before the March meeting. Until the market starts worrying about that, the money will likely keep pouring in.

And as it comes in, it will probably remain concentrated in the stocks and sectors that have been the darlings of the market this year.

"Come the first of the year, when the money comes flying in again, where's the money going to go? Same 100, maybe 200 names," says Larry Rice, chief investment strategist at

Josephthal

. "They ain't going to wake up on Jan. 2 and say, 'Hey Larry, those value stocks you like, those small-caps you like, c'mon, let's buy them.' "