Retail investors taking big risk
The resilience of equity markets has been rather astounding, shrugging off a lot of the negative news and general risks, while short-term sell-offs have met solid resistance from the power of the mighty buy-the-dip trade currently in vogue.
But it isn’t the smart money doing the buying. Recent Bank of America research shows institutional clients have been large net sellers of stocks since mid-February despite receiving large inflows from investors.
We worry, though, that these institutional investors may capitulate if this market continues moving higher, because they’ll face “career risk” as investors tend to fire managers who do not track the upside.
Corporate insiders have also been hitting the sell button. As cited by Mark Hulbert, editor of Hulbert Fi
nancial Digest, officers and directors in recent weeks have on average sold six shares of their company stock for every one they bought. This is more than double the long-term adjusted ratio since 1990 and is the most pessimistic insiders have been in more than 25 years.
With the smart money exiting, who’s behind the bids? Not surprisingly, average retail investors have been huge net buyers of stocks and stock funds since early June of last year. This trend has gained so much momentum that these investors now hold eight times as much money in bull funds compared to bear funds, setting a new all-time high.
All this buying could continue for some time, especially given the constant reminders on how foolish the average investor has been for missing out on one of the best market recoveries in history. But don’t worry, you can always leverage up and buy the dips to play catch-up. Retail investors have for the most part been acting on this advice, sending U.S. margin debt to an all-time record of US$451.3-billion in January. All the excess margin debt is troubling, but what is really worrying is the emergence of those recommending people take out a second mortgage to buy stocks.
This type of advice is typical in frothy markets looking for incremental buyers and, unfortunately, tends to ensnare unsuspecting investors. Overall, the current euphoria is disconcerting, but markets can stay irrational longer than many expect.
Human emotion can be a powerful driver behind market momentum and can temporarily reward those who take excessive risk. However, many forget how quickly it can punish this type of activity when a market suddenly corrects.
If you are considering going all-in or, worse, leveraging up, we recommend taking a step back to examine what your long-term investment goals really are and measure them in the context of the current market environment.