What mutual fund flows say about rising stock prices

Given all the negative economic news, many are wondering why stock prices are rising (the S&P 500 has jumped 10% from its August 15th low and has gained 6.3% from its end of July level).

Valuation factors certainly don't seem to justify this rise. After all, many forecasters are slashing U.S. growth forecasts significantly. Goldman Sachs reduced expected 2008 growth from 2.6% to 1.8%. And long term interest rates haven't changed much, although certain credit spreads have eased.

Most likely, stocks are benefiting from asset allocation changes, as noted here. Lower short-term interest rates make money market investments less attractive, while corporate bonds don't look very attractive given the recent turmoil. That leaves stocks as pretty much as the less ugly alternative.

Capital flow data from mutual funds (a less than perfect indicator, but the only current one we've got) backs this up, to a degree. In August, according to AMG Data, equity funds received a net inflow of 5.7 billion, while taxable bond flows saw an outflow of 0.8 billion. However, money market funds saw a staggering inflow of 156 billion.

In the second quarter, taxable bond inflows were twice as big that equity inflows.

More recent weekly data has been seen similar trends, although it seems that taxable funds are attracting some interest again.