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Stock funds take cash in as muni bond funds lose it

January 26, 2011 |  4:26 pm

Out of one bucket and into another?

Investors yanked a net $5.7 billion from municipal bond mutual funds in the seven days ended Jan. 19, the biggest outflow since the muni market sell-off began in late October, an industry report showed Wednesday.

But some of that money may have made its way into the stock market: Domestic equity funds took in almost $3 billion in the same period, their second straight large cash inflow.

The weekly fund cash flow data, which measure new purchases minus redemptions as tracked by the Investment Company Institute, provide a snapshot of investors’ sentiment toward bonds and stocks.

For most of the last two years Americans have been net sellers of domestic stock funds even as the market has climbed. Instead, investors seeking relative safety have pumped record sums into bond funds, including tax-free muni bond portfolios.

But the cash inflows to muni funds turned to outflows beginning in mid-November as muni bond prices slumped. The sell-off snowballed in the first half of January amid rising worries about the health of state and local governments’ finances.

At the same time, the U.S. stock market has pushed to new multiyear highs this month on continued optimism about the economic recovery. Despite the usual warnings that the rally could fail at any point, the lure of rising stock prices apparently has been too much for some investors to resist.

Domestic stock funds’ net inflow of nearly $3 billion in the week ended Jan. 19 followed an inflow of $3.7 billion the previous week. Combined, the total inflow of $6.7 billion was the most for any two-week period since the first two weeks of May 2009.

Another shift underway: Investors have stopped favoring foreign stock funds over domestic funds. Since 2004, most of the money that has gone into stock funds has flowed into foreign portfolios. But amid Europe’s continuing debt crisis and a slump in many emerging markets this month, foreign funds’ net inflows slowed to $4.4 billion in the last two weeks, or $2.3 billion less than what domestic funds took in.

The inevitable questions: Does fund investors' change of heart about U.S. stocks signal that the market is nearing a peak (i.e., they're too late)? Or is this the start of a shift that could help fuel another phase of the almost 2-year-old bull market?

-- Tom Petruno