Equities Fall Out of Favor With Individual Investors: Q1 2006

Federal Reserve flow of funds accounts for Q1 2006 show the degree to which equity investments have fallen out of favor with individual investors.

Flow table F100 (Households) reports annual rates of net direct sales of equities by individuals of $866.5 billion, an all-time high.

This selling is interpreted as reflecting executives exercising stock options in a massive transfer of corporate wealth to favored insiders through buybacks.

On the other hand, net purchases of equities by individuals via mutual funds — for many years a pillar of the stock market — was only $205.1 billion in Q1 2006 (annual rate).

This means that net disinvestment in equities by individuals was $670.9 billion (annual rate) in Q1 2006 — a record!

*From table F122 (Mutual Funds), we see that 40.9% of net investment in mutual funds was directed into equities. Therefore, we can calculate net investment by households into equities as follows:

Purchase/Sales of Equity by Households, Q1 2006: US$ billions
Direct Sales of Stock -866.5
Indirect Purchases of Stock through Mutual Funds 205.1
= Net Equity Sales -670.9

Mutual Fund Stock Investments Decline

In the year 2000, about 80% of the money that flowed to mutual funds was directed to the equity market.

After the crash, by 2002 less than 20% of net mutual fund sales were allocated to the stock market.

Asset Allocation: Net Mutual Fund Sales

Over the next few years, as the economy recovered from the Clinton recession, the graph shows that the allocation of mutual fund sales into equities increased to about 60% in Q3 2005.

However, the trend has again reversed, with only 40.9% of net mutual fund sales ending up in the equity market by Q1 2006.

High Prices and Baby Boomers

It is not difficult to explain this reversal:

  1. Stocks are over-priced in historical terms, both on the basis of earnings and dividend yields;

  2. The collapse of the Great Bubble of the 1990s has shaken belief in the Common Stock Legend; and

  3. As Baby Boomers approach retirement, they naturally direct an increased portion of savings to fixed income investments.

By mid-2006, the word was out that the impending retirement of Baby Boomers is likely to impair the equity market for years to come.

Professor Jeremy Siegel, author of ‘Stocks for the Long Run’, even predicted that equity prices could fall as much as 50% unless Chinese and Indian investors are willing to buy over-priced equities from retiring Baby Boomers.

To make matters worse, the Federal Reserve Board is bent on spooking the market by raising interest rates, which is interpreted by followers of the Efficient Market Hypothesis as a negative force on stock prices.

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