Investors Cashing Out, Bears Growl

Wednesday, May 19, 2010

There's nothing quite like a 20-minute, 700-point crash in the stock market to scare the hell out of retail investors. The Investment Company Institute reported estimated outflows from long-term equity mutual funds of $12.33 billion for the week ended Wednesday, May 12. Compare this weekly outflow to the $25.57 billion outflow for the entire month of March 2009, the bear market bottom in equity prices. This is a huge outflow as investors lock in profits and force funds with low cash balances to sell positions to meet redemption requests. The historic tailspin on Thursday, May 6th has certainly rattled investors' confidence.

The April consumer price index month-over-month reading came in this morning at -0.1% and core at exactly zero. Despite the Federal Reserve's continued ultra-low interest rate policy the economy is still struggling to fend off deflationary pressures. The year-over-year reading of 2.2% is more encouraging but the inflationary forces seem to be losing steam.

The highly bearish letter out of Richard Russell, publisher of the infamous Dow Theory Letters since 1958, is making the rounds in the blogosphere today. Russell warns: "Do your friends a favor. Tell them to 'batten down the hatches' because there’s a HARD RAIN coming. Tell them to get out of debt and sell anything they can sell (and don’t need) in order to get liquid. Tell them that Richard Russell says that by the end of this year they won’t recognize the country. They’ll retort, 'How the dickens does Russell know — who told him?' Tell them the stock market told him."

There seems to be a large number of bears coming out of hibernation this week predicting crashes in the US equity market. Frankly, I don't see the need to start putting your money under your mattress. Europe certainly has its problems and the long-term future of the monetary union is in question but American companies are still making a lot of money. The stock market hasn't mounted this sustained rally for any reason other than the strong rebound in corporate profits. After a 70% rally the market is due for a rest and sovereign debt issues in the Eurozone are as good an excuse as any. A significant slowdown in China could certainly derail a rapid recovery but that seems to point more towards a correction, not a crash. For now, volatility is high and flexibility is key.
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