Do Investors Hate this Market?

If equity mutual funds flow is anything to go by they are telling us that retail investors do not seem to believe the market at current levels. While the concerns may be logical the stock market does not always follow that logic. In fact extremes and sentiment often lead to the exact opposite.

In 2017 equity fund flows had reached their highest on record both on a monthly basis and a one-year cumulative basis. That ended up marking the final top for the broad market and its eventual decline for over 2 years.

When we look at the chart below from the recent data point when we see the exact opposite. From over 18,000 crores of positive monthly flow to a negative of over 10,000 crores last month means that investors completely do not believe in this rally.

Similar behavior was also seen in the post-GFC (great financial crisis) period. Equity fund flows and the US were negative for several years after 2009. Even after an initial pickup and markets corrected in 2012, fund flows too turned strongly negative. It took a persistent advance and equity prices for that sentiment to change. In fact, in 2011 it almost looked like a 2nd recession could come into play based on data from ECRI. However, that did not happen. In short what financial markets show is the lead-lag between price action and economic activity. The initial buying in any financial market comes from value investors who perceive that prices had fallen too far and started investing looking forward by several years. Ground realities do not change that fast and therefore negative sentiment continues to prevail despite the recovery and equity prices.

This may be similar to what we are seeing today, especially in India. Stocks that have been through 2 to 6-year bear markets are picking up in anticipation of improved economic activity and because there was value in certain sectors like public sector enterprises where dividend yields were in the 6 to 10% range even last month. Investors exiting these equity funds or stocks might therefore make a mistake if past trends are any signal. The negative sentiment at large reflected in data points like these is a contrary signal for equity markets to continue higher.