INSIGHTS

On September 17, 2012

Is Anybody Onboard?

Based on data from the Investment Company Institute (ICI), money has flowed out of domestic equity mutual funds (MFs) for 15 months in a row and over the last 12 months the outflows have totaled approximately $153 billion. Some of that has been offset by the approximate $29 billion of inflows to domestic equity exchange traded funds (ETFs), but on a net basis this still equates to over $120 billion in outflows. In addition, since this current bull market began (3/9/09) money has flowed out of domestic equity MFs in 31 out of 41 months (75.6%). It has been said that bull markets die on euphoria; these outflows don’t look like euphoria to us.

In addition, these outflows are disconcerting to us for a couple of reasons. First, the returns during this bull market have been very strong, with the S&P 500 posting a total return of 133.44% (3/9/09 – 9/14/12), which means many investors have missed a very significant run. Second, though we believe the equity markets are due for a mild short-term correction, we also believe this current bull market has more returns to come and thus many individuals may be poised to miss out on even more returns.

It is always tough to accurately measure investor sentiment or the forces driving that sentiment, but clearly it is being impacted by their recent experiences (a challenging decade) as well as the voice of the media and market commentators. The latter has not done investors a lot of favors over the last 40-plus months of spending, in our opinion, too much time focused on why individuals should be leery of investing in equities vice interested in investing in equities. We have spent quite a bit of time over the last couple of years laying out our bullish thesis for equities and with the Fed’s recent announcement that it would buy $40 billion of mortgage-backed securities each month (QE3 – quantitative easing), we think it can stay intact for the foreseeable future. For starters, we have been taught and truly believe – “Don’t Fight the Fed” – but we also believe that the continuation of this bull market has more legs to stand on other than monetary policy. When the Fed’s proposed actions are coupled with a still resilient U.S. consumer, a recovering housing market and a push towards the United States becoming energy independent over the next decade we believe that the U.S. economy has enough potential energy to continue to grow and avoid a recession despite some fiscal shortcomings and missteps from our government.

As mentioned above, we do think we are due for a mild pullback in the equity markets and this could be driven by a host of factors including, but not limited to, a new surprise out of Europe, the Middle East or even Washington. However, barring any significant and profound changes we would view it as another buying opportunity. In the meantime, we would continue to recommend investors focus on quality dividends and quality growth. We feel this barbell strategy has worked well during this bull market and will continue to do so going forward. Trailing S&P 500 dividends have now eclipsed their pre bear market peak and have grown 16.45% year over year. We do expect this growth to moderate slightly going forward but it should still stay well north of the long-term year-over-year growth of 5.76%. On the growth side, we would favor sectors where growth is expected to be in excess of the broad market. This includes both the technology and materials sector. We expect that the materials sector may even surprise to the upside driven by demand due to rebounds and growth in both the housing and energy industries.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at www.aamlive.com/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com.