Why Flow Data Is Key
For the past few months,
I have been closely watching investor allocations to money market funds
in an effort to measure investor risk appetite. The reason why these allocations
are a good indicator is that during times of uncertainty (geopolitical and
economic) investors seek to preserve their capital, and the highly liquid and
relatively safe nature of money market instruments offer investors peace of
mind. As a result, the size of of the allocations to these funds increases in
proportion to the level of anxiety, while the size of allocations to riskier
assets such as stocks, high yield bonds and certain currencies, decreases.
Conversely, when investors become less concerned
about the future (again, geopolitical and economic) they move out of
“safe haven” instruments, such as money markets, gold, Swiss francs (neutral
country) and Treasuries, and into stocks and higher yielding bonds…
Flow data
According to last week’s investor flow data–for
the week ending April 16, 2003–investors redeemed a total of $29.26 billion
from money market mutual funds, leaving $2.222 trillion worth of assets in these
instruments. Total fund assets, though still high by historical standards,
are at their lowest levels since October of last year–which was before the UN
passed Resolution 1441 in November, warning Iraq that it faced “serious
consequences” should it not comply with the weapons inspections process.
Retail investors pulled $6.73 billion out of
money market funds. Specifically, taxable money market funds (mainly invested in
commercial paper) decreased by 5.09 billion, and tax exempt fund (T-bills and
repurchase agreements) assets decreased by 1.64 billion. As a side note, PIMCO,
the world’s largest bond fund, announced this week that it was again purchasing
GE commercial paper–after having stated a year ago that it wouldn’t be
investing in General Electric’s paper ” in the near future” amid questions about
the company’s credit.
Institutional investors redeemed a total of
$22.53 billion for the week ending April 16. Among institutional funds, taxable
funds decreased by $18.97 billion and tax exempt funds decreased by $3.56
billion.
These net declines in allocations, combined with
the decrease Treasury and gold prices are certainly indicative of the increased
risk appetite. And so far, high yield bond funds have been the main
beneficiaries of this shift in attitude, but in the weeks and months ahead
stocks should also benefit from this higher level of comfort.
Chart Courtesy of Bloomberg
Witness the relationship between the decline in
spot gold, money market funds and junk bonds spreads in the chart above. The
junk bond spread in the graph above measures the relationship between the yields
of junk bonds relative to the yields of the less risky 10 year Treasury. As
investors become more optimistic, they sell Treasuries and buy riskier assets,
such as junk bonds, decreasing the spread between the instruments–which is
usually a good sign for equities.