For more than a decade now, common stocks have fielded a powerful, winning team: declining interest rates, rising corporate earnings, and a massive change in public buying. There has been a lot of comment on the first two players, relatively little on the third.
So lets ask an awkward question: Who will buy our increasingly precious shares?
According to the final tally of mutual fund sales, redemptions, and year-end assets from the Investment Company Institute, the Washington organization that represents the industry, you and I collectively pumped some $476 billion into funds that invest in common stocks in 1996, more than twice the $214 billion we invested in bond funds.
In fact, those figures understate our appetite for stocks relative to bonds because they don’t take redemptions ( redeeming shares owned for cash) into account. When you make that adjustment, investors put $4 into equity fund shares for every $1 committed to fixed income fund shares— essentially what we have been doing since the beginning of 1994.
Investors Prefer Stocks
|
Year |
Net Equity |
Net Fixed |
Total |
%Equity |
|
1994 |
$129,133 |
$15,437 |
$144,570 |
89.3% |
|
1995 |
$134,375 |
$29,276 |
$163,651 |
82.1% |
|
1996 |
$233,599 |
$58,741 |
$292,340 |
79.9% |
Source: Investment Company Institute
That inflow, combined with the massive gains of the last two years, has changed the face of what might be called “the public portfolio”, moving equity holdings up from the 38 percent bottom in 1986 to over 66 percent at the end of 1996. Basically, stocks and bonds have reversed portfolio positions in ten years. ( the table below shows how stocks and bonds have changed positions from 1976 to the present) As recently as 1993, fixed income holdings were slightly greater than equity fund holdings. What we are looking at is a revolution in risk taking by the investing public.
We are all stockholders now… and rather heavily committed ones at that. That means we are also looking at a new reality: we can’t increase our hunger for common stocks much more.
Stocks vs. Bonds in Mutual Funds
Source: Investment Company Institute
Much of this change in investment preferences makes good common sense. Long term, equities provide higher returns than bonds. And if people are actually selling more government and GNMA fund shares than they are buying, there is good reason for that as well: in December, the simple purchase of a 5 year Treasury provided a higher and safer return than an index of 20 major government funds. It has done this now for 39th consecutive months. ( To see the most recent reports and fund listings, go to my website.) As I have pointed out in previous columns, most government securities funds have no reason to live. Investors have willingly accepted more risk in order to increase their investment return.
Which leaves an open question: What will propel further price gains?
It was relatively easy for declining interest rates to allow price/earnings multiples to expand from 8x in 1982 to nearly 20x in 1996. But expansion to 40 times corporate earnings is neither likely nor sustainable if it occurs.
Similarly, while you and I can double our equity investments from 33 to 66 percent, we can’t double them from 66 to 132 percent.
That means two major contributors to this incredible bull market are out of the game for 1997. Future performance is going to depend on a single player: corporate earnings.
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo by Tima Miroshnichenko, Pexels
(c) A.M. Universal, 1997