Stocks Out of Fashion Amid More Bonding

The old saw says the stock market is the only one where customers buy when prices are rising and flee during a sale.

Data for mutual-fund flows bear out this unfortunate propensity for investors to zig when they should zag. But these numbers also show another trend—stocks are going out of fashion. Investors should keep that in mind as the third quarter kicks off Monday with many investors continuing to fear yet another summer swoon.

Figures for the second quarter through June 20 show how seemingly undesirable stocks have become. With heightened volatility and a 3.3% drop in the S&P 500 over the quarter, investors pulled around $44 billion from stock mutual funds and poured $71 billion into bond funds, according to the Investment Company Institute. A less-pronounced version of the same trend was seen even in the first quarter, when stocks rallied nearly 12%.

Indeed, the flight from equities has been going on for about five years. Since the start of 2007, a cumulative $350 billion has flowed out of stock funds and a little over $1 trillion has moved into bond funds. Meanwhile, the mix of consumers' holdings in funds has shifted markedly. In 2011, 45% was in stock funds and 25% in bonds; in 2005, the mix was 55% for stocks and 15% in bonds.

One simple but misleading explanation: There are more bonds around due to rampant deficit spending, even as corporations have been net buyers of stock. But that doesn't explain investment preferences or why Treasury yields are so low.

A more likely culprit is bonds' unusually good performance versus stocks since 2000—a pattern not seen since the Great Depression. That has been compounded by investors' more recent flight to safety. This has led to a high equity risk premium, or the extra return investors demand to hold stocks over risk-free assets. In its simplest form, this is measured by the difference between companies' earnings yield and yields on government debt.

That premium is now unusually high, which has usually preceded good times for stocks. There is no guarantee this will be the case going into the second half of 2012. But it could mean stocks will do a lot less poorly than bonds in the future.

Write to Spencer Jakab at spencer.jakab@wsj.com

A version of this article appeared July 2, 2012, on page C1 in the U.S. edition of The Wall Street Journal, with the headline: Stocks Out of Fashion Amid More Bonding.