Small Investors Warm Up to Stock Funds

Physician David Hurwitz thinks the prognosis is looking up for the long-ailing stock market.

In the last two months, the semi-retired 62-year-old from Woodland Hills has increased his portfolio’s equity weighting to 45% of total assets from 35%, buying shares of the blue-chip Vanguard 500 Index mutual fund as well as Staples Inc. and Genentech Inc.

“The business climate seems to be improving, and the stock market seems to have stabilized,” Hurwitz said. “We’re seeing reasonably good financial reports and earnings numbers, and consumer confidence has stopped going down.”

Encouraged by signs of a livelier economy and by Wall Street’s persistent rally, investors pumped a net $21.4 billion into the nation’s stock mutual funds in July -- the heaviest cash infusion since March 2002, according to industry data reported Thursday.

What’s more, the April-to-July period saw the biggest net cash inflow to stock funds of any four-month stretch in three years. Cash flow measures new purchases minus redemptions.

Individual investors’ return to stock funds has helped keep alive the rally that has lifted key market indexes 25% or more since mid-March.

And it is raising hopes that, despite suffering through the most devastating bear market in a generation, the public hasn’t given up on stocks -- a fear that was rampant on Wall Street last fall, when share prices sank to five-year lows.

“Investors are warming up to the fact that equities have done well for five months in an almost uninterrupted rally,” said Don Cassidy, senior research analyst at fund tracker Lipper Inc. in Denver. “The pattern has had the cumulative effect of bringing people up to a comfort level.”

Still, some experts -- and investors -- question whether long-term faith in the market has returned, or whether many people are likely to quickly run from stocks if the market were to take another sharp hit.

“Are people making a very sophisticated bet that the economy is turning around?” Cassidy said. “They may simply be looking in the rear-view mirror and reacting to recent returns.”

In any case, July was the fifth straight month of stock fund inflows, according to the Investment Company Institute, the fund industry’s chief trade group. The reversal followed a nine-month span in which a net $110 billion was redeemed from stock funds.

Fund companies and private research firms say the inflows are continuing this month, with money piling into a broad swath of stock fund categories.

Mutual funds represent just one avenue of stock ownership, but fund cash flow data, which include buying done through retirement accounts, are considered a good gauge of public sentiment toward the market.

Hurwitz said he, for one, felt comfortable with increasing his equity investments. He said he still owned much less stock, as a percentage of his total portfolio, than at the bull market peak, when equities were about 80% of his financial assets.

Other investors still are holding back, however.

Peter Lang of Boulder Creek, Calif., said he hadn’t put money into stocks this year. “I got caught flat-footed -- I didn’t want to chase it,” he said of the spring and summer rally.

Because September has been the market’s weakest month of the year historically, the 55-year-old Lang remains reluctant to buy in the short term. But he said he thought the chances were “70% or more that we’ll continue to have an up move” in share prices heading into 2004.

“I think it could break to the upside and suck the public in,” Lang said. “There is still a lot of money on the sidelines.”

Indeed, there is a record $6.5 trillion in short-term bank accounts and money market mutual funds, according to Federal Reserve data. Most of that money is earning interest at an annualized rate of 1% or less.

By contrast, the average U.S. stock mutual fund is up 19.4% this year, according to Lipper.

As for his own cash reserves, Lang said, “I may not wait until October” to buy stocks, depending on how the market performs in September.

The recent cash inflows to stock funds have brought relief to the money management industry: Equity fund assets had shrunk from $4 trillion at the end of 1999 to $2.7 trillion at the end of 2002, before recovering to $3.1 trillion as of July 31.

Analysts say fund cash flows this year don’t suggest there’s a buying frenzy underway. In fact, year to date through July, new stock fund purchases still are down 19% from the same period of 2002. But redemptions have declined more sharply, off 25%.

This month through Wednesday, stock funds at Charles Schwab Corp.’s mutual fund supermarket took in a net $1.6 billion, nearly matching July’s inflow, a spokesman said.

Industrywide, stock funds took in a net $6.5 billion this month through Aug. 20, said Bob Adler, head of data tracker AMG Data Services in Arcata, Calif. “Investors are beginning to take risk in the market,” he said.

It’s a different flavor of risk, however, from the late 1990s and 2000, Adler and others said.

Instead of an obsession with large-capitalization growth and technology-sector stocks and funds, investors are diversifying their portfolios, said Kristin Adamonis, research analyst at Financial Research Corp. in Boston.

She noted, for example, that all nine of Morningstar Inc.’s equity-fund style categories had net inflows last month, as did foreign stock funds.

At Schwab, all 10 of its stock fund categories have had net inflows for four straight months including August, a spokesman said.

“People are moving away from fixed income and toward equities, but diversifying,” Adamonis said. “Unlike the late 1990s, asset allocation and diversification are in again.”

When the market began crumbling in 2000, many investors heavily weighted in large-cap growth stocks or funds were pummeled hardest in the subsequent downturn.

What’s more, though recent fund cash inflows have been strong, they have not come at the manic clip of the first quarter of 2000, when a net $130.4 billion poured into stock funds -- just as the bull market was reaching its zenith.

From April through July of this year, stock funds took in a net $68 billion.

That slower pace is giving some market bulls more confidence that stocks’ rally since mid-March can be sustained if the economy continues to revive and the world doesn’t suffer a huge shock, such as another major terrorist attack.

“People are confident, but it’s a cautious confidence,” Cassidy said.