Asset OutFlows: A Contrarian Buy Signal

By Aaron Levitt | March 02, 2010 AAA

If there is one thing that can be said about this market, it's that everyone is uncertain about the future. Volatility is quickly becoming the name of the game. Even the pros are starting to second guess this stock market. A recent survey of money managers reported that only 34.9% are feeling bullish. Five weeks ago, that number was closer to 54%. It's no wonder why retail investors have pulled an $8.8 billion out of stock based mutual funds over the past year and put nearly $410 billion into the bond market. However, these major outflows from stocks maybe the green light to begin to wade back into equities.

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History As A Guide
Even though the current market has gained around 34.3% over the previous 12 months, investors only have about 50% of their portfolios currently in stocks according to retirement plan provider Hewitt Associates, down from around 70% in 2008. Merrill Lynch has made similar findings among the pros. Cash is still king. Hedge funds have reduced leverage and increased cash levels to 4.0% from 3.4%. And global asset managers have upped their holdings of greenbacks to some of the highest levels since June of 2009. (For a review of the global financial crisis, take a look at our Credit Crisis Tutorial)

When investors pull money out of the stock market in vast quantities it is often a contrarian signal to buy. After all, most investors are euphorically bullish at the markets highs and overwhelmingly bearish at the markets bottom. At the beginning of the credit crisis in 2008, investors sold stocks at a record pace. They pulled nearly $227 billion from the market that year, and the following year the S&P 500 (NYSE:SPY) rallied 26.5%. After the tech meltdown in 2002, $27.6 billion fled the markets. In 2003, it recovered 28.7%. Fewer bulls in the china shop could mean that a market rise is in the future.

Ways to Play It
Investors simply wanting to gain broad market exposure could just add to positions in the major indexes such as the DOW via the DIAMONDS (NYSE:DIA) or the S&P 500, however if investors are still worried about uncertainty but want the gains that history says are coming, there are alternatives.

Investors could bet on the mega caps. Overall, large international corporations tend to have stable revenue streams and much stronger balance sheets. Blue chips are better equipped to handle downturns than smaller companies. The iShares S&P 100 Index (NYSE:OEF) follows the largest stocks in the S&P 500 with top holdings in portfolio stalwarts Johnson & Johnson (NYSE:JNJ) and AT&T (NYSE:T).

Cash is fleeing European stocks just as fast as their U.S. sisters. With debt fears about Greece, Spain and Ireland, the euro region is still offering many good investing choices such as Germany (NYSE:EWG). Investors wanting take advantage of this could add the Vanguard European ETF (NYSE:VGK). The VGK is an inexpensive diversified choice, holding nearly 480 large-, mid- and small-cap stocks.

Finally, for those investors with higher risk tolerances, wanting to capitalize on the strength of smaller companies during recovery years, both the Vanguard Small Cap Value ETF (NYSE:VBR) and the iShares Russell Microcap Index (NYSE:IWC) are great ways to introduce smaller companies into a portfolio.

Bottom Line
With fear beginning to return to the market it is important to look at all the positives before making an investment decision. Historically, major outflows of capital from stocks signal very positive gains the following year. Currently, fright is once again making investment strategy. Now, maybe a good time for long term investors to pounce on stocks and the broad ETFs above are a great way to do that.

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