New Year, New Interest in Stock Mutual Funds

Small investors are buying stock mutual funds again, to the great relief of the fund industry--and quite a few market bulls.

Major fund companies report that cash inflows into stock funds have picked up sharply this month, after waning in November and early December to the lowest levels since the summer of 1991.

“January is turning out to be one of our better months in a while,” said a spokeswoman for Baltimore-based T. Rowe Price Associates, in a comment echoed by other funds.

The dramatic slide in new fund purchases--and rise in redemptions--in November and December had sparked fears that small investors were fast losing interest in the stock market after two years of seemingly insatiable fund demand.

With stock prices last year suffering their worst declines since the bear market of 1990, Wall Street worried that a sustained drop-off in fund purchases would remove one of the few remaining sources of support for the struggling market.

But analysts weren’t sure whether to attribute the slowdown in fund activity in November and December to investor nervousness about the stock market’s next move or to seasonal factors. For example, many individuals now know to halt fund purchases late in the year, to avoid buying an instant tax liability as funds make year-end capital gains distributions.

Investors’ renewed buying this month suggests that much of the slowdown in stock fund demand was, in fact, technical. What’s more, because many investors make decisions about retirement funds in January--where to invest their 1995 IRAs, for instance--the pickup in stock-fund purchases may indicate that stocks still are being favored for retirement accounts, despite rising yields on bonds and bank CDs.

An informal canvassing of large fund companies shows nearly all of them are seeing increased buying of domestic stock funds and/or a drop in redemptions this month:

* T. Rowe Price said Friday that its stock funds’ net cash inflow (purchases minus redemptions) had already topped December’s total--with 11 days left to go in January--and was “on track to reach October’s levels.” Industry-wide, funds saw a cash inflow of $9.2 billion in October, three times November’s depressed inflow.

* At the Vanguard Group in Valley Forge, Pa., spokesman John Woerth said the firm’s stock-fund inflows so far this month are 2 1/2 times December’s levels and “on par with August and September.”

* The Denver-based Janus Funds’ stock-fund inflows are on track to total $550 million this month, up from $334 million in December, the firm said.

* Boston-based Scudder, Stevens & Clark Inc. has seen a net $45-million flow into its U.S. stock funds this month, up from a mere $2.5-million inflow in December.

Not surprisingly, the return of stock-fund buyers since November has coincided with a rally in the stock market that began on Dec. 9, when the Dow industrial average stood at 3,685.73. Even after last week’s profit-taking, the Dow still is up 5% since Dec. 9, to 3,869.43.

Any thought that stocks could fare well without public support via mutual funds should have been laid to rest by last year’s bond market fiasco. When individuals turned from being heavy net buyers of bond funds to being heavy net sellers beginning last March, the bond market entered its worst bear period in 60 years.

Yet it may also be a mistake to think that continued high mutual fund demand alone can jump-start Wall Street’s stock bull market. Consider: Despite unprecedented stock-fund net cash inflows of $78 billion in 1992, $128 billion in 1993 and at least $114 billion last year, the Standard & Poor’s index of 500 blue-chip stocks has risen just 11% in price since the end of 1991--or about 3.5% a year.

So a lot of public money has swept into stocks, but the net effect since 1991 has been to keep the market’s head above water, and not much more.

*

The Bond Paradox: Although stock fund demand has revived, many mutual fund companies say bond fund demand is mixed at best. The extraordinary cash outflows of last year appear to have slowed or stopped, but where fund investors are buying bonds, it isn’t with much conviction.

The U.S. Treasury probably won’t have that problem this week, as it sells new 2-year and 5-year notes in auctions Tuesday and Wednesday, respectively.

As interest rates have surged over the past year, small investors have become huge buyers of shorter-term Treasury securities, even as they exit bond mutual funds.

Buying Treasury notes direct has advantages for investors who might otherwise own bond funds. For one, interest on Treasuries is always exempt from state income tax (though not federal), a real advantage in high-tax states. Some “U.S. government” bond funds, on the other hand, may own government-agency bonds whose interest may not be exempt from state tax.

Also, investors who own individual Treasury securities don’t have the safety concerns of bond-fund investors, who may worry that their fund manager is experimenting with exotic “derivative” government securities such as the kind that brought down Orange County’s investment fund.

Most important, owners of Treasury notes know in advance that they’ll get all of their principal back when the note matures--a promise that bond funds can’t make, given the vagaries of the market and interest-rate cycles.

Of course, when you buy a Treasury security direct, you’re locking yourself into a set interest rate for the life of the security. Bond funds, in contrast, pay higher yields as market rates go up.

But with 2-year T-notes yielding about 7.5% currently and 5-year notes yielding about 7.8%, those returns are attractive enough to persuade many investors that buying and holding Treasuries is a terrific deal.

You can buy Treasuries direct and commission-free from the Federal Reserve (call (213) 624-7398 for information) or via brokers or many banks for a relatively small fee. Minimums to buy direct: $5,000 for 2-year notes, $1,000 for 5-year notes. Many brokers, however, do not accept orders for less than $10,000.

*

Briefly: Despite some Wall Street pros’ fears that surging consumer debt levels will soon sink the economy, Kemper Financial Services economist David Hale says that “American business cycles do not typically slow because of consumer debt reaching excessive levels.” Rather, economic growth slows when interest rates reach levels that cause businesses to stop expanding and hiring, causing consumers to fear for their jobs. We’re not there yet, Hale says. . . .

Morningstar Inc., the Chicago-based mutual fund rating service, has begun identifying stock and bond funds that invest in derivative securities. The firm’s fund reports now show whether a fund can and does own securities in any of four “special” classes: illiquid stocks or bonds; exotic mortgage-backed bonds; structured notes; and options or futures. . . .

In a survey by investment firm Lutheran Brotherhood, 49% of 1,000 investors interviewed said they have “prayed for guidance in how to manage their finances.”