And for retail investors.  Guys, you are always wrong.   As Jeremy Warner pointed out, there is a terrible negative correlation between retail buyers being bullish, and the market’s subsequent performance.  I don’t want to sound like a paranoid Marxist, but there seems to be something almost systemic about it:

  • Rising markets don’t generate headlines until a long way into the rise.  Then they are euphoric – glowing profiles of genius CEO’s, and so on
  • Information dribbles out more slowly to the retail punter than the City insider, so they react more slowly to bad news.  So they wait for an accumulation of buys, which means buying higher.
  • Retail punters need the ‘comfort’ of a large herd of similar people, who take similar views.  Better to fail in company than alone . . .
  • Falling markets produce shock headlines that affect the risk-aversion of retail people. So in April, you are still digesting the bleak stories of Feb-March, even though that is when to buy.

I saw this over and over again in the Dot Com madness.  I even wrote a clunking satire on the process, which is still by far the most recommended post in the “investment psychology” section (no, I didn’t have a life, for a few months).

John Authers today pointed out how extremes of sentiment are negative indicators:

Another great contrarian indicator is the survey of sentiment by the American Association of Individual Investors. Last week, this showed the lowest proportion of self-described “bears” since February 2007 – when volatility first started to spike as investors at last began to grasp the severity of the subprime mortgage crisis in the US.  Bearishness in this survey hit an all-time high in March last year when the current rally first started, showing how much money can be made by betting against extremes of sentiment.

The result, as investopedia tells us, is that private punters are way worse than the market index.  They buy high, sell low. This has very worrying implications for liberals believing that leaving people to their own devices tends to maximize their own interests:

In 2001 Dalbar, a financial-services research firm, released a study entitled Quantitative Analysis of Investor Behavior, which concluded that average investors fail to achieve market-index returns. It found that in the 17-year period to Dec 2000, the S&P 500 returned an average of 16.29% per year, while the typical equity investor achieved only 5.32% for the same period – a startling 9% difference!

Like Dillow, I think markets are unpredictable.  But the best rule is: if you meet anyone in a pub with a clever stock tip, sell everything.*

*then what do you make of this post?  Is it a negative negative indicator?  If anything is obvious, it is probably wrong . ..

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6 thoughts on “Bad news for the stock market

  1. Most retail investors invest a set amount each month, in some sort of tracker or quasi tracker. They are unlikely to be far out from the index. It is individual investors in individual shares who are the group you are describing. I would be surprised were they to be a large number of people.

    Liberals never claimed everyone got everything right, all of the time.

    Even I bought fewer shares last spring than I would have done, in retrospect!

    1. I think you are too phlegmatic, although perhaps the type that I am imagining – the sort to take a large, discretionary decision – belongs in the top quintile of prosperity, and perhaps should not bother us too much. For example, I am sure that, no matter how accumulated, a great number of people liquidated holdings between September and March last year in response to the radically changed circumstances and outlook.

      Chart 2.21 in the Financial Stability Report makes interesting reading. Net monthly inflows from Sep 2008 to March 2009 have averaged 0.93billion – April to October 2009 have averaged 2.7 billion. This massive buying must be influenced by lack of alternatives.

      But going back further, the general weak behaviour of retail funds in the previous months make them look cleverer. However, the pattern is not, at a macro-level, of regular monthly amounts regardless – there is discretionary decision making taking place.

  2. Some yes, but if you also included pensions – which is how most people access the stock market – then discretionary purchases are a very small proportion. And as you say, these people are not poor. Virtually no-one on below median incomes will be buying shares. The rich can spend money on the sort of things in the how to spend it section (which makes great wrapping paper, by the way), or on dabbling in shares. Why should the rest of us mind what they do?

  3. I tend to agree. And given the ability of people to time entry to the market (it hit a peak around the beginning of 2000), it is probably just as well that pension funds make the decisions instead.

    But I still maintain that how these – rich – people behave is a good counter indicator. You are right that it is not a major policy concern. In a way, their bad trading is a useful redistributive tool (albeit to already fat brokers and dealers).

  4. I have been in the stock markets for the last 25 years in various capacities in India. I started my career with a stock brokerage firm, later I did my own research portfolio management etc. for my nearest and dearest and for my self. Also I have gone through books of Investors of world fame.
    Now my observation is quite at par with that of yours’. Over a period of 25 years I have observed only a contrarian can earn money in the stock markets this the game of only two emotions i.e. greed and fear.As Warren Buffet puts it “Be fearful when others are greedy and be greedy with others are fearful.” Perception may be different from the reality. And moreover perception originates from our emotional brain and reality originates from our rational brain. But we are programmed to take a short cut to the situation that is present. So be cool and take a rational approach not react to which we have been conditioned by the large players through media news (rather noise the most effective variable of stock markets..) and stock market movements. Take your time. It is well said about the stock markets “do the hardest thing and avoid the easiest” this is where a contrarian is born.
    Rajiv Kaushik India.

    1. I quite agree Rajiv – though I was only in the markets 1996-2006. This is why I started cautiously selling yesterday, some of the stuff picked up a year ago.

      I know I will not have picked the top – but trying to always get the top and bottom is a good example of th ebest being the enemy of the good.

      cheers

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