Moving out of equities

By Felix Salmon
July 12, 2010
Jim Browning has a big story today saying that small investors are "fleeing stocks" and "running for cover". And interestingly, this is not a particularly new phenomenon, and it predates the big crash of 2008:

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The WSJ’s Jim Browning has a big story today saying that small investors are “fleeing stocks” and “running for cover”. And interestingly, this is not a particularly new phenomenon, and it predates the big crash of 2008:

flows.gifAfter getting hurt in the 2000 tech-stock crunch, individuals came back to U.S.-stock funds in 2003, as stocks were entering a new bull market, ICI data show. But the buying proved tepid and turned to net selling in the latter part of 2006, even before the bull market ended in 2007. Despite occasional periods of inflows to U.S.-stock funds, the selling trend has continued since then.

It’s only natural for buy-side types to look at this data and conclude that this is a great buying opportunity — but I’m not so sure. Browning concentrates on investors who are rotating out of equities by choice, but I suspect that a lot of what’s going on here is a matter of necessity: people are selling their stocks because they have to, not because they want to. After all, they no longer have the ability to take out home equity lines of credit whenever they run into a liquidity crunch.

There’s also a certain amount of delevering going on, which is encouraging: Browning talks of one investor who sold a third of his stocks and used the proceeds to pay down the mortgage on his second home. Sensible.

And while Browning talks of the new conservatism as emblematic of the way in which the stock market is being left to large institutional investors, the fact is that underneath their monolithic exteriors, those big investors are mostly just aggregations of little investments at heart. It’s entirely possible that retail investors are ahead of the curve, here, and that institutions will end up following suit: what are the chances that they will continue to see inflows rather than outflows, over the long run?

What’s undeniable is that it makes a lot of sense for the “comfortably retired” Karen and Roger Potyk to sell their stocks. If you have enough money to live on, why take the risks associated with equities? Especially when doing so makes you feel bad about yourself morally?

“In the military, you learn that you want people you can respect, trust—who have integrity,” Mr. Potyk says. “Over the last five years or so, I find that our financial institutions have no shred of the character I describe.”

The last straw was the May market volatility, accompanied by widespread fears about European government debt. On May 20, the Potyks asked their financial adviser to sell the last of their stock mutual funds.

Now that their portfolio consists entirely of fixed-income investments, “I won’t make 8% on my money. I will make 4% or 5%, but the money will be there,” says Mr. Potyk.

It’s worth noting here that Mr Potyk still thinks of stocks as something which can and should return 8% a year, despite the fact that they’ve done nothing of the sort for the past decade. In that sense, we haven’t had a real capitulation yet. It’s rational to exit the stock market even if you think it’s going to go up, so long as you also think there’s a serious risk it’ll go down, and you can’t afford to lose that hard-earned money. But for the time being, in the public mind, stocks are still things which go up over time. Which says to me that there’s still at least as much downside as there is upside.

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