As Money Flees Equity Funds "Dry Powder" Moves To Sidelines

A mystery wrapped in an enigma. Money is cashing out of equity funds at an alarming rate. Much of that goes into money markets funds. If the stock market ever goes up again, that liquid capital could come back and fuel a rally. But when? And, in the meantime, does investment capital continue to pull out of stocks?

According to the FT, a study from Emerging Portfolio Fund Research shows that $100 billion was taken out of equity funds in the first quarter. Most of that came out of funds with stock investments in the US and Europe. While the withdrawals may hurt equity fund company earnings, it hurts the stock market much more. As investors yank money to the sidelines, funds have to sell stocks to supply the capital for people to cash out. That, in turn, helps drive markets further down. But, a stock rally might bring that money back.

Every silver lining has a cloud. The falling performance of equity funds will further withdrawals which could easily extend into the second and third quarters. Doom without a prophet.

The optimist’s view of this is based on the perverse notion that, once markets begin to move up, cash from money markets will flood into the market to chase the rising value of stocks. The trouble with this reasoning is that investors have be burned by several sucker rallies over the last year, and they may not be so quick to follow the next caravan. Capital could slip into Treasuries or corporate bonds.

Theories are good until practice proves them wrong. Investors are not anxious to return to the stock markets.

Douglas A. McIntyre