One of the best and most challenging parts of the banking business is that each year, you basically start over. It is the same ritual with the markets and 2011 has all the makings of a much better year than the last three for the U.S. economy and, hopefully, our industry.
The historic emergency government intervention actions like TARP and the bond buy-back programs (QE1 and QE2) are winding down at the time of this writing because they are not needed anymore. The Dow Jones Industrial Average recently hit a four-year high and there are many other much more positive trends in the economic data now. The job market remains as the main drag on the economy.
I have been monitoring the funds flow from stocks and cash positions into bond funds over the past two years. As you probably know if you read my column regularly, I am a big believer in studying the emotions and ensuing actions of investors for clues about the future direction of the markets. Bond fund flows have proven over the years to be one of the best contra-indicators for the stock and bond markets due to the greed/fear decisions investors frequently make when markets change.
Investors tend to sell their stocks when the stock market is falling and then buy bond funds for the extra yield they seemingly offer versus bank CDs and other lower-risk options. As you can see in the chart, approximately $700 billion has shifted into bond funds since December 2008. You can see the sharp reversal in red last December. While not perfect, I think this is a valuable tool for predicting the direction of stocks, interest rates and the economy this year.
Click here to view a larger version of the chart.
Investors tend to quickly move excess cash into bond funds for extra yield, usually without considering the fact that they can lose principal as interest rates rise. When this fact hits home, you then often see large outflows, and more of that action may be ahead this year. This reversal probably bodes well for stocks and means higher yields for bonds at least over the short run as it appears the economy is on the mend.
Banking will hopefully be more fun this year.
Best wishes for a very prosperous 2011 and a special thanks to BankNews for the privilege of writing in this space for the past 21 years. I hope I have helped you sleep a little better at night.
Jeff Goble is executive vice president and managing director, investment banking, at UMB Bank, n.a., Kansas City. His email address is Jeffrey.Goble(at)umb.com.
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