Investors on the Verge of a Stock Fund Breakdown?

When individual investors collectively decided they’d had enough of bond mutual funds earlier this year, they helped spark the century’s worst bond bear market--the end of which still isn’t in sight.

Now, Wall Street fears that small investors may be reaching a similar threshold with stock mutual funds, after a record four-year buying binge.

The hint of a significant turn in stock fund owners’ sentiment is surfacing in major mutual fund companies’ reports on November purchase trends. With rising interest rates on money market funds and bank CDs providing increasingly tough competition for stocks, many fund companies say their stock funds either suffered cash outflows this month or took in very little in new money.

Boston-based giant Fidelity Investments, for example, says a net $100 million has flowed out of its stock funds in November, meaning redemptions exceeded purchases by that sum--the first outflow in eight months. In contrast, Fidelity’s stock funds had a net inflow of $550 million in October.

Kemper Funds in Chicago also have seen a net outflow from stock funds this month, as have Invesco Funds in Denver. At Massachusetts Financial Services in Boston, stock fund cash flows are positive by $7.5 million this month, but that is way down from October’s $102-million inflow.

*

At some fund companies, stock fund purchases were still on a healthy track until last week’s market plunge. T. Rowe Price Associates in Baltimore says its stock funds are still showing a $130-million net inflow this month, but that $100 million flowed out when stocks dove last week.

Even before the market’s latest setback, however, fund industry statistics suggested that investors’ appetite for stock funds was waning.

The funds’ trade group, the Investment Company Institute, said Tuesday that stock funds’ net new cash flow totaled $9.3 billion in October. While that was up from $8.1 billion in September, the two-month total of $17.4 billion was down from $23.3 billion in the July-August period, $19.5 billion in May and June, $17.9 billion in March and April and $32.7 billion in January and February.

For bond funds, meanwhile, the news continues to be dismal: The ICI says bond funds saw a net $7.9 billion in assets leave in October, up from September’s $4.7-billion outflow and the eighth consecutive monthly outflow. And many fund companies say bond fund redemptions have worsened in November from October’s brisk pace.

The latest outflow numbers may seem relatively small compared with the $891 billion in assets still in stock funds and the $711 billion still in bond funds. But markets are made at the margin; it often takes only a change in the trend of money flows to create a new bull cycle--or a new bear cycle.

Ever since February, when interest rates started to rise and investors began pulling more money out of bond funds than they’re putting in, the bond market has been in a virtually continuous slump, unable to sustain any rallies.

Of course, mutual funds aren’t the only owners of bonds and stocks; pension funds, banks, insurance companies and other institutional investors also make up the market.

But with the explosion of stock and bond fund assets since 1990, the funds--as conduits for individual investors’ dollars--have become increasingly important players on Wall Street. If they aren’t buying, and worse if they’re selling, it may be very tough for markets to mount a rally.

“We definitely feel that the funds are a very critical factor now,” says Andy Engel, senior research analyst at market research firm Leuthold Group in Minneapolis. If stock fund purchases continue to trail off, he says, “that could be the driving force” behind a new bear market in equities--the first since 1990.

At the very least, “If you lose the mutual fund buyer, you might get a vacuum in the market for a while,” warns Richard McCabe, director of market analysis at Merrill Lynch & Co. in New York.

To be sure, the recent drop-off in stock fund purchases could be as much a seasonal issue as a sign that investors are growing wary of the market. Tax-loss selling accelerates at this time of year, and many investors wisely delay new fund purchases in November and December to avoid taxation on year-end capital gains distributions.

But with short-term interest rates at their highest levels in more than three years--and still rising--many fund company executives admit that investors may simply be making the logical choice, for now, by shunning stocks in favor of money market funds, bank CDs or even bonds.

After four years of unprecedented stock fund purchases, “investors have made a fairly heavy commitment to equities” by now, notes Fidelity spokesperson Jane Jamieson. With the market stumbling and short-term CDs paying 6% or better risk-free, “it may be that some investors are re-evaluating.”

Peaking Out?

Bond mutual fund assets have dropped 7% since Jan. 1, and some Wall Streeters now believe that stock fund assets also may be peaking. Assets in billions of dollars.

Bond funds: $711

Stock funds: $891

* Source: Investment Company Instutite