lems simply did not matter to the stock market beyond their effects on earnings and interest rates, and that they could not damp down the generally optimistic attitudes of investors.
The changes in institutional funds flows into equities approximated the pattern of changes in price-earnings ratios beyond what was indicated by interest rates, as the share of institutional funds flowing into equities rose from 10.2% in 1978 to 21.6% in 1981 and 26.6% in 1983; however, emphasizing funds flows as a causal factor is problematic. Increased institutional flows were matched by declining household flows, and there is no reason to emphasize one over the other. Net institutional purchases were also too small relative to trading volume to be a major factor in stock prices, accounting for only 5.6% of NYSE volume during 1980-1984. 23
The changes in funds flows are better considered as reflections of causal forces in stock market valuation than as causal factors themselves. The rare occasions when funds flows may be considered an independent technical factor in stock market valuation have occurred when a particular market sector has diverted abnormal proportions of funds into stocks, ignoring portfolio allocation factors. For example, private pension funds allocated 90% of their funds flows to stocks in 1968-1971, and there is some evidence of skewed institutional funds allocations leading up to the crash of 1987. More recently, household mutual fund purchases in 1993-1996 have influenced stock values. But even in these cases there is nothing about the flows themselves to indicate whether they reflected fundamental or other factors.
The early 1980s witnessed a dramatic recovery in the stock market after the punishment of the 1970s, when price-earnings ratios for the S&P 500 shrank from 17.9 to only 7.0 and the S&P 500 underperformed by 86% what was indicated by a two-factor model using changes in interest rates and earnings. The higher price-earnings ratios of the 1980s and the stock market's renewed responsiveness to changes in earnings and interest rates reflected the new regime brought about by the activist role of the Federal Reserve in fighting inflation, the policies of the Reagan administration, particularly its tax cuts, and the combined ability of the Federal Reserve and the administration to keep the crisis in the banking system between 1982 and 1984 from disrupting the economy and the securities markets.
The impact of the new regime was immediately obvious in the second half of 1980, when the Federal Reserve righted its policy course after a period of embarrassing volatility and the stock market began to antici-