Friday, January 18, 2013

Investors Flock Back to Stocks

Some professionals believe that retail investors are an excellent contrary indicator. They claim it's a good time to buy when the man on the street throws in the towel and vows to stay away from stocks; and it's a good time to sell when retail investors come flocking back into the market. Well, it seems the flocking has begun.

Retail investors have pretty much avoided stocks ever since the financial crisis of 2008. What scared them was the 38.5% decline in the S&P 500 that year. Diversification provided no protection as correlations jumped and everything sold off. But by getting out of the market, they missed the 23.5% rally in 2009 and the 12.8% gain in 2010. The market finished flat in 2011, but there was tremendous volatility. The S&P 500 moved up or down by at least 1% on 69 trading days during the second half of the year alone. Investors, of course, don't like losing money; and they dislike volatility almost as much.

The markets really settled down in 2012 and the S&P 500 climbed 13.4%. It seems that the reduced volatility and the double-digit gain were enough to entice many investors back. U.S. equity funds pulled in $18.3 billion during the first full week of trading this year. That is the fourth largest amount of weekly inflows ever. BlackRock, the world's largest asset manager, saw huge inflows of money into its passively managed equity funds during the fourth quarter of 2012. The pace of inflows has continued into 2013. Some of this is new money, but much of it came out of bond funds; and BlackRock said that at least some of the money came out of actively managed equity funds.

There have been many times in the past when investors got out of bonds and into stocks at the wrong time; but there is something a little different about this rotation. Although investors are flocking back to stocks, they are not interested in making their own picks. Instead, they are going into passively managed index funds, especially exchange-traded funds.

Several years ago I had the privilege of hosting Jack Bogle, founder of The Vanguard Group, for lunch. Mr. Bogle is a long-time advocate for passive investing. Although he isn't fond of ETFs (because he thinks they encourage trading), he must be very pleased with the growing interest in index investing. Let's just hope this rotation is not signalling another market top.

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