The latest information regarding the flow of funds into and out of US equity mutual funds confirms that the private or retail investor was a heavy seller of US equities during July.
The majority of private investors in the US invest in the stock market through mutual funds. The total amount invested in these funds is enormous and trends in these funds are closely analysed by specialist consultants such as Lipper and by the Investment Company Institute, which is the mutual fund industry trade group.
In July, mutual fund investors are estimated to have pulled approximately $50 billion (€51.5 billion) out of equity mutual funds. This compares with a withdrawal of $18 billion in June and with a $30 billion withdrawal in September of last year after the September 11th attacks.
While the absolute scale of these withdrawals is large, $50 billion still only represents about 1.6 per cent of the total stock of assets invested in the US mutual fund industry. Nevertheless, it is clear that withdrawals from equity mutual funds of this scale during July is a major factor explaining the sharp fall in share prices over the month. A key question is whether the July exodus reflects an ongoing trend or whether it was more of a once-off panic wave of selling.
Share price movements in recent weeks provide some support for the view that the normal pattern of steady investment in equity markets may have resumed. For example, in the week ended August 21st there were net inflows of $3.2 billion into US equity mutual funds.
Global stock market indices over the past month have now recouped quite a lot of ground, as can be seen from the table. This recovery in share prices has been strongest in the US as exemplified by the S&P 500, which has risen by 18 per cent over the past month and even the technology-laden Nasdaq has risen by 12 per cent. Across Europe rises in share prices have also been widespread with the FTSE Eurotop 300 up by 13 per cent and the FTSE 100 up by 14 per cent over the past month.
Despite this recent bounce back in share prices virtually all equity indices are still in negative territory in the quarter-to-date due to the severity of the declines in July. Nevertheless, if this stronger late-summer trend continues into September, then some stock market indices could conceivably crawl into positive territory for the third quarter as a whole.
Of course stock markets could also be hit by the re-emergence of negative sentiment, leading to a reversal of this recent partial recovery. However, there are some reasons to be cautiously hopeful that the worst of the bear market may be over.
Firstly, fears of a double-dip recession in the US are probably overdone. The flow of information concerning US economic indicators points to an economy that is growing, albeit at a slightly below- par pace. US corporate profits have now stopped declining and from now on should show a positive trend of quarterly growth. Official dollar short-term interest rates remain at a 40-year low of 1.75 per cent.
At the height of the equity market bear market there was some speculation that the Federal Reserve would reduce interest rates to as low as 1 per cent. Recent statements by a number of Fed governors have effectively scoffed these rumours. Nevertheless, the minutes of the most recent Fed meeting indicate that interest rates will be kept at low levels until there is clear evidence of inflationary pressures. Therefore, economic prospects for the US economy will continue to be supported by historically low interest rates for the foreseeable future.
The picture painted by economic data across Europe as whole tells a similar story. Economic growth across the region as a whole is positive but does vary quite significantly from country to country.
However, as long as the US does not suffer a double-dip recession it is likely that the European economy will grow at an acceptable pace. The ECB continues to hold short-term euro interest rates at 3.25 per cent and is unlikely to change interest rates before the end of the year. The recent improvement in the value of the euro and better news on inflation means there is now no justification for any rise in euro interest rates.
In fact if the European economy were to falter, the ECB has more scope to cut rates than its US counterpart.
Therefore, a modest quarter-point cut in euro interest rates is not out of the question before the end of the year. As long as the economic backdrop in Europe and the US remains relatively benign between now and the end of the year, there is a strong chance that share prices across the globe can continue to recoup the losses experienced over the course of the bear market.
