Smoke Signals

Exodus
When the final numbers are compiled, June 2013 may prove to be a "bloodbath on the level of October 2008," says Morningstar's Syl Flood. Fortunately, Syl doesn't track the total returns of mutual funds, so he's not referring to performance. Rather, he tracks fund flows, where the numbers have been striking.

In June, investors redeemed funds across the board. Not just traditional mutual funds, but also exchange-traded funds, which until recently had enjoyed steady inflows. U.S. stock funds, emerging-markets stock funds, bond funds, gold funds--even best-seller DoubleLine felt the pain, as  DoubleLine Total Return Bond (DBLTX) suffered more than $1 billion in net redemptions for the month, despite performing in line with Barclays U.S. Aggregate Bond Index.

My next-desk neighbor Russ Kinnel has been fielding calls from journalists asking if these flows represent an inflection point. After five years of favoring bonds, commodities, emerging markets, and alternative investments, they wonder, are investors "rotating" back to conventional U.S. stocks? As Russ patiently explains, the answer appears to be no. At the moment, fundholders are clearing out of anything that carries risk. There's no evidence that they have a renewed appetite for domestic stocks.

Per yesterday's column, that's good news for the asset class. May the neglect continue. As for the other investments of bonds, commodities, and alternatives, their current unpopularity has been much too short to be a positive indicator. Or a negative indicator, for that matter. A month's worth of cash flows means nothing.

Cashing Out
Not every contrarian signal proves useful. One that didn't was the level of cash held by stock mutual funds. Back in the day, this data point was closely scrutinized. The idea was that if mutual funds held an unusually high amount of cash, they would soon need to put that cash to work. That buying activity would help to boost stock prices. Conversely, a low cash position signaled that stocks funds were tapped out. At best they couldn't support the market and at worst they would be forced to sell equities to raise cash.

Such was theory. In practice, not so much. A typical example would be in August 2011, when stock fund cash levels were at record lows. Per the mutual fund cash signal, stocks had nowhere to go but down. The signal of fund flows, on the other hand, was more favorable. Which indicator would be stronger? No contest that: The S&P 500 gained a cumulative 35% over the following 22 months. As signals go, fund flows tends to be pretty strong. 

More Is Less? 
Another possible indicator is new fund launches. Unlike with fund flows, which Morningstar has tested extensively, there's no data to support my hunch that investment categories that spawn a large number of new funds are too popular, overbought, and therefore due for a fall. Anecdotally, however, the proposition makes sense. Tactical allocation funds sprung into existence following the stock market crashes of 1987 and 2007, only to trail as stocks rebounded; new technology funds were the rage in the late 1990s; and emerging-markets stocks haven't been great investments since BRIC funds (Brazil, Russian, India, and China) rolled out in the mid-2000s.

If such a signal were to be useful, it would now show caution for gold funds, real estate funds, and municipal-bond funds. Those are the three areas that have had considerably more funds created in the first half of 2013 than in the first six months of 2012. Not sure what to make of that possible signal for caution. Gold? Of course. But real estate would seem to be a timely investment, as it's presumably early into its recovery off the bottom. And munis? Other than the general concern about bond funds amid low interest rates, I can't see a particular danger with municipal-bond funds.

More work to go with that signal, I should think. 

The Quick Brown Fox 
Josh Brown tweaks us via Twitter: "Is it me or is Morningstar getting a bit lazy - just rolled out a new fund category called "Miscellaneous." Josh presumably learned that from the Morningstar Fund Spy article called "The Reasoning Behind Our Newest International-Stock Category," which discusses a stock category called "miscellaneous region." However ... the adjective miscellaneous is not new for the Morningstar system, as "region" follows "sector" and "trading" as the company's third "miscellaneous" category.

Yes, I know--it's an instant world; impossible to get them all right. Tell me about it. 

Kudos to Thad
Fortunately, I have a cadre of editors to watch over me. A clever cadre, at that. Yesterday's link to a Monty Python sketch? My editor Thad Doria's idea. Thad later supplied the following line: "There is only one thing worse than doing nothing, and that is not doing nothing." That suggestion arrived too late to be inserted into yesterday's column. But not too late for today. 

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.