Money has been fleeing the stock market as fast as the market has been rising, leaving open the fear that, once again, mom-and-pop investors will come back only after missing the best part of the rally.
The trend of retail investors to buy high and sell low is one of the oldest — and most confounding — traits of the stock market.
And true to form over the past four years, and in 2012 in particular, money has been leaving the equity and money markets and pouring into bonds. This has happened even as the Standard & Poor's 500 has gained more than 110 percent off its financial crisis lows.
However, there are some halting signs that investors are ready to put money to work.
Exchange-traded funds have been a substantial beneficiary of the mutual fund exodus. Investors increasingly are choosing ETFs as a way to play the market, and flows there suggest some investors actually are beginning to come back to stocks.
The worry is that by the time the trend accelerates, the rally will be over and it will be too late to benefit from stock gains.
"They're always late to the party," says Nadav Baum, executive vice president at BPU Investment Management in Pittsburgh, Pa. "The reality is we haven't had a real good fundamental stock market with growth and companies buying back stock and splitting and dividends since 1998.
"If in fact we are getting in this period of a true, strong market where the fundamentals are good, the companies are buying back stock and they're increasing dividends, that could keep the market going for 10 years. At some point, retail will be back in."
But whether that will be too late and whether the retail investor will ever come back are two nagging questions.
Examining mutual fund flows as a proxy for investor behavior has become a favorite pastime for Wall Street pros, the media and the blogosphere, and the story from there — albeit only partially true — suggests a caravan out of stocks.
Investors have dumped more than $40 billion from stock-based mutual funds in 2012 alone and about $535 billion since 2008, while bond funds have taken in $950 billion, according to data from the Investment Company Institute.
The good news for investors is they've been rewarded handsomely for diving into fixed income. While the rewards were not quite so gaudy as the stock market's the risks were far less and thus obviously more pleasing.
Changing that behavior, then, won't be easy.
"Typically, the retail investor needs to get burned. When they actually get burned, they will leave an asset," says Quincy Krosby, chief market strategist at Prudential Annuities in Newark, N.J. "As long as they've felt they're doing all right and there's no risk, they've been quite happy in these various assets within fixed income."
The issue, most everyone agrees, is that
"Mind you, many retail investors are very well diversified, so they have exposure to equities. They've been in high yield, which is very highly correlated to equities," Krosby says. "So they have returns in their portfolio. The issue is, do they start increasing their allocation?"
There's a much under-examined aspect of the fund-flows chatter that tells a somewhat different story about investor behavior.
While it's true that equity mutual funds have been hemorrhaging cash, that money isn't all going to bonds.
Many investors instead are showing preference to exchange-traded funds, which are composed like mutual funds but trade like stocks. The $1.3 trillion ETF industry has seen huge inflows at the same time that mutual funds have been losing investor cash.
Domestic equity ETFs have jumped from holding just $370 billion in assets at the beginning of 2008 to $702 billion now, according to ICI.
That's not quite a 1-for-1 correlation and it doesn't mitigate how much investors have been taking out of money markets and pouring into bonds. But it's certainly an indicator that the retail investor isn't quite so fearful as the mutual fund flows indicate.
But the perception among many pros is that confidence remains lacking, and until that returns in the stock market the retail crowd likely won't, either.
"To some extent, isn't that what it's always about?" says Liz Ann Sonders, chief market strategist at Charles Schwab in San Francisco. "There's muscle memory from the severity of the financial crisis. We had two bubbles in a 10-year period. You had the lost decade. You have the Flash Crashes and all the mini-flash crashes from other stocks."
Sonders has been mostly bullish on the market during its rise from the crisis depths, and believes that despite the various dangers looming the market can keep climbing.
"It's an overused term, but we're continuing to see the green shoots," she says. "They bring out the animal spirits that are just bubbling now."
It's also worth noting that while equity mutual funds have taken a hit in recent years the industry still holds $5.6 trillion in assets, including $4.2 trillion in domestic funds. Those are numbers that suggest plenty of investors have seen benefits even if the trend is moving away from stocks.
"That's why retail investors should have advisors," BPU's Baum says. "They keep buying bonds, and they are going to take a hit with inflation. These interest rates are going to keep going up, and people are going to get hammered in these bond funds."