If you're waiting for individual investors to rush back into the stock market any time soon, don't hold your breath.
As the slide worsens, with the Dow Jones industrial average slipping an additional 249 points Thursday, it is becoming increasingly clear that investors who have pulled money out of stock funds in recent weeks or have refused to put fresh money in will continue to sit on the sidelines until the roller coaster comes to a complete stop.
This could signal a much slower recovery for the stock market and could handcuff mutual fund managers who are already strapped for cash, market watchers say.
"If they stop putting money in, it's a strong indication we're in for a prolonged bear market," said James Stack, editor of the InvesTech market newsletter in Whitefish, Mont., and a longtime bear.
It would also mark a major turn in investor behavior from the two most recent flat years for stocks, 1994 and 1990, when investors shook off short-term corrections, interpreting them as buying opportunities, and quickly returned money to stock funds.
Indeed, investors haven't shown this degree of caution since 1987, following the October crash that erased about a quarter of the value of the stock market.
"Following October 1987, I could remember we were well into the spring [of the following year] before the collective wisdom was that we weren't going into a recession," said Susan Byrne, manager of the Westwood Equity Fund.
And it took 21 more months before money flowed back into stock funds in a significant and consistent way, according to the Investment Company Institute, the mutual fund industry's chief trade group.
"I think to some extent, we're seeing that right now," Byrne said.
Notes Jim Stratton, president of Stratton Capital Management in Plymouth Meeting, Pa.: "The investor is frozen at the wheel right now."
And until it's absolutely clear that the correction is over, "they're going to take money out of equity funds and they're not going to put more in as they had throughout the bull market," said Gerald Perritt, editor of the Mutual Fund Letter in Largo, Fla.
"The huge rush into equity funds will be broken by this market," he declared.
In August, investors pulled a net $5.4 billion out of equity funds, according to the Santa Rosa-based research firm Trimtabs.com. That marked the first negative month in eight years, since the 1990 bear market.
Trimtabs now estimates that a net $5.7 billion will flow into stock funds in September. If the projection holds, it would still mark a 78% drop in cash flows to stock funds from the same time last year.
The severity of the current market plunge is one reason many believe investors will take a "wait and see" attitude like they did in 1987--and didn't do in 1994 and 1990.
According to Ibbotson Associates, August ranked as the 10th-worst month for the stock market, as measured by losses in the benchmark Standard & Poor's 500 index of blue-chip stocks, since January 1926.
The S&P; 500 fell 14.5% during the month.
No month in the 1990 bear market and the 1994 correction came close, Ibbotson researchers said. In fact, the only other month in the latter half of the century that saw such a severe downturn was October 1987.
"Compared to historic bear markets, 1990 was nothing," said Perritt. "We cured the '90 bear market with a single missile," he added, referring to the quick end to the Persian Gulf War, which had helped spark the downturn in stocks.
Analysts are not predicting money will flow out of stocks to the degree it did in 1987 and '88.
Starting in October of that year, investors pulled money out of stock funds in 17 of the following 21 months, yanking a net $27.7 billion.
This time around, analysts expect cash flows to remain more or less flat.
"Historically, what happens in these periods is that fund flows fall off--whether that means buying at lower levels or actually having outflows," said John Rea, ICI's chief economist.
Rea notes that one reason we may not see actual outflows during this stretch is that Americans are now increasingly automatically investing money in mutual funds every month through their company-sponsored 401(k) retirement plans.
And, unlike 1987, when money funds were returning more than 6.1% a year, investors are finding it increasingly difficult to find alternative investments to stocks that provide decent yields. Money market funds this year, for instance, are yielding just 5.2%.
The real concern is that prolonged bear markets have a lingering effect on investor psychology.
James Stack of the InvesTech market newsletter notes that in 1971 and 1972, when stock prices began to rise coming out of the 1969-70 bear market, investors continued to pull money out of mutual funds. The same was true for 1975 and 1976, as stocks were recovering from the severe bear market of 1973-74.