Market eyes retail inflows
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With 11 months of stock-market rebound already behind us, the inevitable question is being asked: Where will we find the money to sustain the rally?
Scotia Capital believes it could come from the pockets of the Canadian retail investor.
Economists Derek Holt and Karen Cordes said that net sales of equity mutual funds in Canada (not a perfect measure for total retail investing, but a reasonable proxy) historically have risen in line with the S&P/TSX composite index - only with about a six-month lag. And they believe history is about to repeat itself.
TURNING THE CORNER?
Net equity-fund sales were still in the red as of the 2009 fourth quarter - meaning more money was taken out than put in, for the fifth straight quarter. However, the trend has been improving slowly: Net redemptions have shrunk for four straight quarters.
Mr. Holt and Ms. Cordes believe this improving trend is evidence that the historical pattern is more or less intact. And, based on the typical two-quarter lag between when year-over-year S&P/TSX returns turn positive and when equity-fund sales return to the black, "the rally in equity markets is just now at the point at which it should begin to translate into retail inflows," they said.
The S&P/TSX composite posted a 22-per-cent year-over-year gain in the fourth quarter, its first positive return in six quarters. That implies that equity mutual fund flows would turn positive in the 2010 second quarter - although the economists allowed that it could come earlier.
"Indeed, the most recent period ... suggests that the reaction time is perhaps a touch faster this time around."
EXCEPTIONS - THEN AND NOW
The Scotia Capital economists did note the historical trend didn't count for much in the mid-2000s, when a strong uptrend in the stock market was met with stagnant sales in equity mutual funds.
They attributed this to the popularity of income trusts. As the chart shows, by adding income trust inflows to the equity-fund net sales numbers, Mr. Holt and Ms. Cordes found the historical trend was intact in the mid-2000s.
Now, though, the income trust market has exaggerated the retail exodus during the market downturn - likely a function of investors unloading income trusts in advance of tax changes in 2011. That could continue throughout 2010.
However, what Scotia Capital's data don't show is the hot trend that may be replacing income trusts: Exchange-traded funds. ETFs actually managed to post positive net sales in 2009, even while equity mutual funds were stuck in negative territory. The popularity of ETFs looks likely to continue to pull business away from mutual funds in 2010.
But while flows into ETFs might distort the historical trend between fund flows and stocks, they would still represent inflows of retail investment into the market.
Add it up, and it would suggest retail investors may join in the market upturn - even if it took them a while to arrive at the party.
