This weekend the New York Times put out an article highlighting how small investors are “flee[ing] the stock market.” It’s an interesting piece that highlights some of the complexities of today’s trying economic times. There is no one reason for why people in aggregate are withdrawing money from equities; however, it is clear that each individual reason for this phenomenon can be traced directly to lingering concerns in the wake of the financial crisis.
According to the Times:
Investors withdrew a staggering $33.12 billion from domestic stock market mutual funds in the first seven months of this year, according to the Investment Company Institute, the mutual fund industry trade group. Now many are choosing investments they deem safer, like bonds.
Later on in the article, the Times proceeds to explain how “investors nerves were…frayed by the “flash crash” but I think they glossed over the topic a bit too much. The times did highlight the fact that investors withdrew “$19.1 billion from domestic equity funds in May”; however, they did so without digging a little deeper. Out of the $19.1 billion withdrawn in May, $14 billion (or 73% of the withdrawals) occurred in just one week directly after the Flash Crash. This is a staggering sum.
I have argued that the Flash Crash was a major catalyst behind the “unusual uncertainty” and recent volatility spike in the stock market. Sure volatility was picking up amidst the European crisis, and even before the Flash Crash went from down day to consequential event on May 6th, markets were taking an intraday beating. Yet a strong pullback should not come unexpected after an 80+% rally from lows to highs in equity markets over the past year.
To many, seeing their money instantaneously disappear then reappear was a shocking and unnerving event. It gave many a frightening demonstration of the fact that in equities, money can in fact be lost rather quickly. This helps explain why money continues to pile into corporate bond funds despite macro uncertainty. Individuals want exposure to some kind of long-run returns, but do not want that exposure at risk of losing a substantial portion of their wealth. Especially with hardship withdrawals from 401(k)s on the rise. Americans understandably are more risk averse than in years past.
The New York Times offered the following observation about individual investors:
One of the phenomena of the last several decades has been the rise of the individual investor. As Americans have become more responsible for their own retirement, they have poured money into stocks with such faith that half of the country’s households now own shares directly or through mutual funds, which are by far the most popular way Americans invest in stocks. So the turnabout is striking.
I get the impression that in talking with many who grew up, matured and earned the majority of their living between the 1960s and 2000s that the stock market moving higher had been accepted as a given. People believed in the stock market as a vehicle on the path to personal financial success with returns averaging double-digit percentage gains per year. Between the dual bubbles over the past 10 or so years, that sentiment has slowly shifted to where it is now. While many still understand and believe in the stock market as a vehicle for wealth, there is a far deeper acknowledgment of the risk element inherent in equities. A monthly chart of the S&P clearly highlights the lack of returns in equity markets over the past decade:
One problem I see with equities at this point in time is that everyone wants to buy a sure thing. Not only that, everyone wants to be “in the money” the second in which they place an investment. Such an expectation was nearly practical in the past half-century, but is far more difficult today. That’s not necessarily a good or bad thing, it simply is. Investment is an inherently uncertain endeavor and that is exactly why investors are paid a reward for making investments. One of the key drivers behind the stock market expansion in the post-World War II era has been a willingness to embrace this uncertainty in the quest for opportunity.
This phenomenon further explains the transition to bonds. While bonds offer lower returns, people are far more confident in their return of capital, which justifies the lower level of reward relative to equities. One element that I, as an investor, find intriguing about the NY Times article is the contrarian indicator factor. Typically when an investment vehicle completely loses favor is exactly the time in which the potential returns are greatest. Sure the macro landscape looks “unusually uncertain,” but at the same time, corporate balance sheets look incredibly attractive, yields on Dow stocks are exceeding those of Treasuries, and dynamic growth and innovation are changing the ways in which we store, process and consume information. With the uptick in M&A, as well as IPO filings over the past two weeks, it seems that some still understand this concept. Afterall, it is one of the core tenets of Benjamin Graham’s time-tested value investing strategy: buy into the Bear to sell into the Bull.