Despite the well-known advice to buy low and sell high, most people do the opposite. If the stock market is rallying people start putting their money into equities, worried they might miss the rest of the bull run; when it’s tanking they pull their money out. This reflexivity creates momentum that drives rallies (and crashes) farther than the fundamentals dictate as people without much investment experience decide they can’t stay out any longer (or curse their decision to bet on stocks later on).
Buying stocks with a second mortgage is sentiment out of control
The normal measures of sentiment that investors look at include people on the inside – informed investors and analysts that have good reason for their opinions – but reflexivity also includes first-time investors who get caught up in media speculation about future growth. That’s why articles that tell people to get a second mortgage and put money into equities should worry people.
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First, just to get it out of the way, if the family house is your sole asset, taking out a second mortgage to invest in the market is probably a terrible idea. Your risk adjusted returns have to be higher than the interest you pay on the mortgage, and there’s nothing wrong with holding an illiquid long-term asset anyways. For a family with little extra income to give up the security of home ownership to chase the market could practically be the definition of frothy sentiment.
Inflows from first time investors can keep weak stocks afloat
But even if you aren’t worried about other people making mistakes with their assets, their actions could directly impact your investments. Losses from the financial crisis may have soured some people on the idea of investing in the stock market, but last year’s incredible gains could be enough for them to put aside their concerns and get back into the market. Or, in the case of a homeowner reading articles like the one above, they might see this as their big opportunity. But even analysts who are bullish over the next few years have consistently warned that there could be a correction sometime this year. If that correction is avoided because new investors are pouring money into the market, valuations could easily overshoot.
As always, timing market turns is easier said than done, but as the general excitement around the stock market builds, value investors should be keeping one eye on the exit.