Following the recent recession a lot of money flowed out of the stock market, with investors instead opting to take a more conservative approach. The reasoning behind the move was fairly straightforward… less volatility. A lot of money was lost during the recession, so it made sense that investors would look for lower risk alternatives, even if the lower risk meant lower upside potential.
However, we have now started to see the trend reversing. In fact, during the first week in January we saw the money flowing into stocks at the fastest rate since September 2007.
We have been anticipating a rotation back into stocks for the past few years, and now it seems as though it is finally happening. There are two reasons I believe that traders are putting money back into the market… performance and dividends.
Despite all of the troubling headlines regarding the fiscal cliff and the eroding situation in Europe during 2012, the market performed OK… actually better than OK. During 2012 the DOW was up 7.3%, the S&P 500 rose 13.4%, and the tech heavy NASDAQ posted a 15.9% gain. These numbers for sure are going to catch a lot of people's attention, especially with interest rates near zero.
Secondly, there are the dividends. In most cases, dividend-paying stocks are paying out a higher yield than what you can find in the bond market. High quality bonds are currently paying yields below the rate of inflation, so people are actually losing money in the bond market. The math is enough to push investors back into the equity market.
With so much money flowing back into equities, you could view this as a positive indicator on the overall health of the market, but we must also be cautious about reading too much into the money shift. Any time we see a quick move in anything market related we have to consider that the move is actually a contrarian indicator.