As economic activity continues to plunge around the world you have to wonder when we will get the public capitulation that we expect to take place before or coincident to reaching a climatic low in the market. Equity mutual funds (EMFs) attracted more money in absolute terms than at any other time in history during the late 1990s ($220 billion/year) with $140 billion coming in the first quarter of 2000 (the largest purchases in any one quarter ever-- by a lot). When the public feels enough pressure during major secular bear markets they will eventually liquidate equities and equity mutual funds en masse. Historically, the amount of liquidation reaches close to 10% of the total amount of EMFs and sometimes, like in the late 1970s it reaches close to 10%/ annually for a number of years.
The Global economy is continuing to deteriorate. Japan has recently warned that their current recession may last as many as three years. Germany has warned that their economy will probably fall by as much as 2.25% in 2009, the largest decline since the federal republic was founded 60 years ago. Surging UK employment is causing a slowdown in their average hourly earnings while mortgage lending fell 47% in December. Singapore said its economy could possibly shrink an unprecedented 5% this year, leading then to initiate a stimulus package of as much as 8% of GDP. With the U.S. jobless rate showing unrelenting increases there are massive stimulus packages taking place here and worldwide. The Bank of Canada slashed its key interest rate to 1%, the lowest since it was established in 1934. Malaysia's central bank cut its benchmark interest rate by 75 basis points, while Brazil's central bank stated that it will probably cut its benchmark interest rate for the first time in 16 months.
It is possible that all of the bad economic news around the globe, which is forcing unprecedented stimulation, is discounted in the marketplace. After all, the market is supposed to be forward looking, and there is no question that the poor worldwide economic news is not a secret. However, we believe that the public has not come close to liquidating the equities and EMFs that we expect to take place with the worst global recession and bear market since the Great Depression. Although culture, technology and financial instruments undergo great change over time, human nature remains the same and emotional highs and lows in financial markets are a fact of life that never changes. An example of the emotional highs and lows are the financing and marketing of oil and gas tax shelters in the early 1980s, when Wall Street marketed every deal that couldn't be sold in Texas. This demand coincided with the peak in oil and gas prices leading to heavy losses, bankruptcy, and the necessity to bail out every sizable independent bank in the state. Does this remind you of another market that Wall Street took under its wing to market? Again, they had no problem selling repackaged mortgages to their clients that eventually led to the financial mess we are in presently. Time after time, it's apparent that the public always buys heavily what it just recently missed, and subsequently liquidates with major losses.
Ned Davis Research (NDR) has been keeping track of mutual fund customers' purchases and liquidations for many years and we have often included the NDR charts in our comments and special reports. However, these charts have shown sales and redemptions as a percentage of total market capitalization. In order to render the data more relevant we recently asked NDR to show these net purchases and sales as a percentage of the total assets of domestic equity mutual funds (attached chart). A number of observers have recently published charts that they interpreted as indicating capitulation by the public. However, these charts generally showed net liquidation in dollar amounts rather than as percentages of EMF assets.
The new charts that NDR prepared for us indicates that we came close to liquidating 10% of the total assets in equity mutual funds for several consecutive years in the late 1970s after liquidating about 4% of the total assets in 1973 and 1974. If NDR did not include re-invested dividends in their purchase statistics before 1978, the liquidation in the late 1970s would show that liquidations would have reached around 12%. We also had net liquidations coincident with the crash of '87 of over 10%. As can be seen on the chart, the liquidation that took place last year did not come close to matching these other difficult market periods of time, and we would therefore expect to experience liquidations of around $450 billion (on $4.5 trillion of fund assets) before this financial episode is over.
This doesn't mean the liquidations will occur before or after the market low is reached as much of the liquidations took place after the 1974 bottom and coincident with the 1987 bottom. However, we do believe that there will be a public capitulation that will be at least as severe as the last two significant bear markets (especially since this one is accompanied by a major worldwide bear market and recession).