RETAIL INVESTORS TAKING ON SIGNIFICANT RISK IN TODAY’S MARKETS. THAT RARELY ENDS WELL.
Don’t be caught last one on the dance floor
The evolution of today’s investment industry from a relationshipbased model into a low-costtransaction model over the past decade has no doubt had a positive impact, creating greater market efficiencies while lowering fees for investors.
One thing it hasn’t done, however, is change the risk paradigm. Rather, it has fed into the existing pattern, encouraging many to take on and take off risk at precisely the wrong times.
Expectations change during market extremes as euphoria builds on optimism, and pessimism on negativity.
Take today’s euphoric environment, in which nearly two- thirds of individual investors believe that the U. S. stock market will go higher in the next six months and in which for every bearish investor there are nearly fourand- a- half bulls, testing levels not seen since 1987.
The problem, though, is that the average investor is usually the last one to join the party.
The central banks were first up, running their printing presses in overdrive, lowering interest rates and buying bonds and even in some cases equity exchange traded funds ( ETFs). The Central Bank of Japan, for example, admits to owning approximately 75 per cent of the assets of ETFs listed in the country.
Then it was corporations themselves taking advantage of record low- cost debt and, instead of reinvesting into capital projects, deciding in many cases to financially engineer growth via massive share buyback programs.
According to the IMF, U.S. corporations have US$3 trillion of negative net equity issuance since 2009, due to share buybacks with nearly two- thirds of it funded through debt.
Led by the U. S. Federal Reserve, the majority of G7 central banks will have ended their buying programs by the end of the year, with some, such as our own Bank of Canada, having already started to tighten. Corporations have also pared back their purchases as interest rates start to rise and share prices become too expensive. The S& P 500, for example, is trading at more than 2.3 times sales, a level it hadn’t touched since the days of the internet bubble.
And what are regular investors doing in this environment?
During the past four weeks they purchased US$58 billion of equity funds, the largest inflows ever, according to BAML. According to the December AAII Asset Allocation Survey and as reported on Forbes, individual investors now have 72 per cent of their portfolios in stock and stock fund allocations, just shy of the record high of 74 per cent in July 2000 ( most of us remember what happened that year).
The industry is all too happy to feed the ducks as all it takes now is a click of a button for investors to return- chase their favourite market or sector to their hearts’ desire.
With such low fees, size is now critical for ETFs to be profitable — and so the race is on to get to market first with products to meet strong i nvestor demand based on the fear of missing out (FOMO).
There are plenty of examples of this in today’s environment — simply look at the new marijuana, cryptocurrency and robotic/artificial intelligence ETFs. Interest rates rising in Canada along with the loonie? No problem, we have an ETF for that. Want to join the record speculator long positions betting on the global reflation trade? Try this oil or emerging markets ETF. And on and on …
What really worries us the most in all of this is what happens when these individual investors decide to hit that sell button all at once and the underlying assets an ETF owns suddenly go no-bid. Consider this: the Financial Times cites a recent survey by the Index Industry Association showing that there are more than 70 times as many stock market indexes as there are quoted stocks in the world.
With all this going on, taking the time to understand both your actions and emotions before you hit that buy/ sell button has never been more important.
This doesn’t mean one can’t enjoy the party — just that practising moderation, either on your own or with the help of an adviser, will prevent a serious hangover when the music stops playing and you realize you’re the last one on the dance floor. Martin Pelletier, CFA is a Portfolio Manager and OCIO at TriVest Wealth Counsel Ltd, a Calgary- based private client and institutional investment firm specializing in discretionary risk- managed portfolios as well as investment audit and oversight services.