Retail Investors are Not Abandoning the Stock Market

Retail Investors are Not Abandoning the Stock Market
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I’ve seen a spate of articles lately on retail investors abandoning the stock market. Here’s a sampling:

  1. Cult Figures — Bill Gross
  2. Stock bulls have a beef with Bill Gross — Jonathan Burton
  3. Why Are Investors Fleeing Equities? Hint: It’s Not the Computers — Andrew Ross Sorkin
  4. Small investors vs high-speed traders — Felix Salmon

I chose these because I think they add to the discussion.  In general, I think there are a decent number of retail investors, that have left the markets, or reduced their exposure.

But I saw this back in 2002, when I saw many friends leave the stock market because of the losses they were taking.  Several said to me, “I am going to invest in what I know — I’m sticking with real estate.”  I winced and stuck with stocks, and had phenomenal performance in 2003.  I paid off my mortgage, and considered selling my house in 2005, but I realized for me, a house is not an investment — it’s a place to live.

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Retail Investors are Not Abandoning the Stock Market

After 2008, more people concluded the stock market was rigged.  Why?  Because they lost money, and that couldn’t be their fault.  Sorry, but retail investors, and many professionals too, give way to fear and greed, and chase trends.  They are not invested at the bottom, because they are too scared.  They are invested at the top, because it is the “thing to do if you want to make money.”

Call my point 1 this: People who don’t understand investing buy and sell at the wrong times.  They panic and get greedy.

Point 2: People don’t get that returns are lumpy.  They happen in spurts, over months, years, decades.  This is the big problem with financial planners — they assume smooth returns that will assure a retirement.  Sorry, but market moves in regimes, and is not easily predictable.  There are a few two decade periods where the market goes nowhere.  They are not anomalies; the value of companies are catching up to their prices.

Point 3: The estimates of equity outperformance sold by consultants, financial planners and naive journalists exaggerate the reality.  Here’s the reality: equities perform maybe 1% better than Baa/BBB bonds, particularly when you analyze the investments on a dollar-weighted basis.

Point 4: Everyone loves a winner.  People were spoiled by the returns of the 80s and 90s, and that validated in their minds the idea that more stocks are better; the projections of the financial planners are conservative; equities always beat bonds.

Point 5: Most ignore long-term valuation metrics, whether professionals or retail.  Whether it is the:

  • Q-Ratio
  • CAPE
  • Price-to-Resources Ratio
  • Whatever John Hussman has cooked up
  • Eddy Elfenbein’s view the stock market as a bond measure

they say roughly the same thing at present: equities are overvalued long-term.  Short-term is another matter: P/Es aren’t that high and momentum is running.  But how short is your horizon?  This makes sense if you are willing to play for months, not years.

Point 6: Professionals changed too.  In this market environment many professionals have started to trade more, as if we don’t trade too much already, and I think this is the wrong response.  As professionals, we need to do due diligence, and pick stocks we can be happy with for some time.  High frequency trading affects those who are not clever at trading.  Those who are clever disguise their trades making them look small like retail.

Point 7: But regardless of who holds stocks, they are still held by some entity.  They don’t disappear.  They move from weak hands to strong hands.  The trouble for retail investors is that they are weak hands on average.  They can’t handle disappointment, versus value investors who buy when there is disappointment.

Yes, I understand the frustration of average investors who do not do well; you are novices in a complex market.  Maybe you should just buy BBB bonds.  With the abnormal economic policies of our government, it is difficult to make any decision.

Personally I don’t think that retail investors are abnormally disappointed at present.  This is just market noise — we face overvaluation, but positive momentum.

Me?  I keep owning undervalued companies for myself and clients.

By David Merkel, CFA of Aleph Blog

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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