Opinions Investor's Corner Revenge of the retail investor
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Investor’s Corner
By John Gudritz CFA
Principal
Front Street Investment Management LLC
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Retail investors have always been the Rodney Dangerfields of the investment industry. They get no respect from investment professionals and media commentators. In fact, their actions in the financial markets have historically been used as contrary indicators because the majority of them usually ended up buying high and selling low in a market cycle. So if they were buying in mass, the smart money would be selling.
However, according to the flow of funds reports from the mutual fund industry, the individual retail investors actually got it right this time. They saw what was happening to the economy in late 2007 and early 2008 and were in the process of reducing their exposure to the stock market. They seemed to sense the bear market coming and began to take action to get defensive.
While some market pros will grudgingly concede that many individuals did make the right call early in the bear market crash, they will also point out that those same people have never come back into the stock market even when it was down over 50 percent in March 2009. They missed this big recovery rally from the bottom.
That is true. As I have commented in previous columns, retail investors have used the rally in the stock market to continue to take money out of the stock market and to put it into bonds. However, considering the large returns that bonds have earned over the past year, these individuals are feeling pretty good about their decisions to reduce the risk in their portfolios and focus on income.
It has been amusing for me to listen to the talking heads on financial stations like CNBC confidently proclaim that the retail investor was missing out on the big market rally and would be coming back into the stock market any day now as they always do. My response to all of them has been, “Don’t hold your breath.” In my opinion, they are not coming back to the stock market in mass anytime soon.
The retail investor gets it. They understand what is going on in the economy as well as the stock market and they don’t like it. Many of them are experiencing first-hand the weakness of this so-called economic recovery as they or people they know remain unemployed.
With consumer spending representing 70 percent of the U.S. economy, most people also know that we are going to have to start to see a lot more hiring in this country to ensure that the recovery continues. Consumer demand can’t improve without increases in income, wealth (i.e., investments and housing prices) or credit, and that is just not happening in any of those areas.
Higher income is dependent on higher job growth and in recent months it seems job growth has stalled out. Weekly initial unemployment claims have been rising to recessionary levels of 500,000 and the unemployment rate has been stuck at 9.5 percent.
The retail investors also get it that the prices of their homes are not going up anytime soon. All they have to do is look around their town and count all of the for sale signs. I think that many of them are also wise to the fact that many banks are sitting on bad mortgage loans waiting for a bottom in the real estate market to foreclose on a lot more homes. They know it will be a long time before they are able to have a substantial amount of equity in their homes again. That is not just a fear. It is real.
Consumers have seen their access to credit diminish over the last couple of years. Home equity lines of credit have been cancelled for many homeowners. Credit card companies have cut lines of credit and banks are only lending to people with high credit scores.
Because of these realities in the economy, these people know that they are going to have to save more and spend less going forward if they want a decent retirement. And it is happening. Many CEOs of retail companies have recently commented on the fact that their customers are only buying what they need and not so much of what they want. Conspicuous consumption is no longer chic among the rich.
Retail investors also get it that the better than expected corporate earnings have come from cost cutting, which include layoffs, not from revenue growth. They know that many companies are coming to the end of producing positive earnings surprises by just cutting expenses.
Individual investors are much smarter and more sophisticated about the investment world than they were in the 1990s. They no longer believe in the “buy and hope” long-term investment strategy that many professional managers still advocate.
They recognize a secular bear market when they see one as opposed to many of the investment pros who are stuck in a mindset that is hazardous to their clients’ wealth. And their actions to reduce risk and focus on income have proven to be the right strategy. But then I am biased because that has been my firm’s strategy since 2008, as readers of this column know.