The past few weeks have seen a surge of inflows into US equity mutual funds, following many years in which investors have preferred allocating money to bonds rather than stocks. The week ended January 9 saw the fourth largest weekly cash flow into equity mutual funds since 1992, and large investment companies such as BlackRock have spoken of a sea change in the opinion of small investors towards equities. Some analysts see this as the start of a great rotation from bonds into stocks, thus reversing the pattern of the last decade.
Others, however, point out that cash inflows from small investors tend to be contrarian indicators, since they are often driven by recent market behaviour, rather than by fundamental valuation, which is what actually determines market returns in the long run.
An interesting academic paper has recently appeared on this topic, written by two behavioural economists from Harvard, Robin Greenwood and Andre Shleifer. The paper, which is well summarised here in Free Exchange in The Economist, discusses the signals that can be derived from investor sentiment and flow data, and then contrasts these results with some standard predictions from the theory of finance. Given their results, some unexplained puzzles remain. Read more