Insights & Advice

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Can you blame them?

From May through September of this year, retail investors yanked over $90 billion from stocks funds. If you include the money investors have taken out of mutual funds since January, 2007, the total is almost $250 billion. The question is whether or not the little guy will ever want to come back to the market?

Does the little guy stand a chance?

It is not too difficult to understand why investors have abandoned stocks en masse. The declines and losses most investors experienced in 2008-2009 were traumatic. Many investors never returned to the equity markets, but preferred, instead, to keep their money in bonds or money markets. Those who did participate in the subsequent stock market rally from March, 2009 to the beginning of 2011 made quite a bit of their money back.

This year, however, the individual investor experienced a level of volatility that was beyond comprehension. It didn’t matter whether you were invested in stocks, mutual funds or exchange traded funds, or in defensive areas such as dividend stocks or preferred shares. Nothing was immune and the volatility was insane.

Consider the movement in the S&P 500 Index for one thirty day period in September through October of this year: Up 8.31%, Down 7.34%, Up 5.34%, Down 5.68%, Up 7.38%, Down 8.70%, Up 7.34%, Down 10.14%, Up 6.65%.

By the end of the third quarter the Dow, S&P and NASDAQ all lost more than 12%, the worst decline since the fourth quarter of 2008. If you were invested in Europe, the results were even worse with Germany, Italy and France all down over 30%. Between the volatility and losses, no wonder the few hardy souls who had stuck with the market since 2009 have decided to abandon ship.

Their desertion has drained a great deal of liquidity from the markets over the past few years. Liquidity is a term used to describe the ease in which you can purchase or sell a security without moving the price higher or lower by an appreciable amount. In a recent story in the Wall Street Journal “Traders Warn of Market Cracks”, several Wall Street traders argue that it is increasingly difficult to trade large amounts of stock without moving the market (price level) substantially.

We have all heard of high frequency trading (HFT) by now. These HFT firms represent about 2% of the 20,000 trading firms that operate in the markets today but account for over 73% or more of trading volume. Directed by computerized algorithms, hi-speed computers buy and sell in mini-seconds capturing tiny profits (less than one cent per share in many cases) over and over again 24 hours a day around the world.

In calmer market environments, HFT does provide additional liquidity in the markets and actually drives down costs. Where the system breaks down is in volatile markets like we have today. These traders are geared to make small amounts of money on large volumes. When good (or bad ) news hits and markets begin react “in size” the HFT firms back away from trading, which instantly causes a 73% drop in liquidity at the very time it is needed most. It is what happened during the “Flash Crash” in May of last year.

In addition, some critics are blaming certain leveraged exchange traded funds for contributing to the volatility in the markets. ETFs have experienced explosive growth in the last five years and now accounts for 40% of the daily trading volume. The use of ETFs that provide 2 and 3 times the amount of exposure to an underlying index, they say, causes excess buying and selling that would not occur otherwise. ETF defenders argue that leveraged ETFs only account for 4-5% of volume and are simply reflecting market sentiment not causing it.  A subcommittee of the U.S. Senate has opened hearings on the issue this week.   

The bottom line, in my opinion, is that today’s stock market environment is no place for the retail investor unless you have help from a professional. Rampant insider information between government and Wall Street, both here and abroad, overnight trading by professionals that effectively prevents the individual investor from participating in the market’s big moves, and the above volatility factors make the markets an unfair arena for most of us.

Posted in A Few Dollars More, Portfolio Advice