A Record Breaking Half for Fund Flows

Stocks keep hitting records, there hasn't been even a pullback for six months, and investors are feeling good. And what do investors do when they're feeling good? Why, they add to their bets, of course.

Through June, equity mutual funds and ETFs have taken in more than $122 billion in assets, according to Lipper. That's the best first half for flows in almost 20 years. The only first half that exceeds this flow, in or out, was the pandemic-inspired outflow last year.

This is a bit restrictive since it's only looking at flows through the first half of each year, but it's still more extreme than any other 6-month stretch in 20 years.

A LOOSER LOOK AT FLOWS

If we remove the calendar and just look at every rolling 6-month period, we're still seeing a record flow. While it exceeds the prior record from 2013, it only reverses some of the outflows from 2019 - 2020.

This is also a bit misleading because it ignores the fact that the overall size of the market has grown.

HIGH FLOWS = LOWER RETURNS

When we adjust fund flows for the total market capitalization of the U.S. stock market, then the past six months don't seem to be as much of a driver as other periods. It's less than half the extremes reached in 2003, 2011, and 2013.

Still, there was a consistent contrary nature to investors' behavior. The higher the flow, the lower the S&P 500's annualized forward return. When it exceeded 0.2% of market cap, which it currently is, then the S&P 500's annualized future return was perfectly flat. That's far below the other periods when flows were less extreme or (especially) when there was an extreme outflow.

The biggest thing stocks have going for them is long-term momentum. There have been some shorter-term signs of internal deterioration, so that's a worry, as is the continued too-optimistic nature of sentiment. Fund flows are another sign that complacency is high enough to be a concern.