Retail Investors and the Stock Market

I’ve seen a spate of articles lately on retail investors abandoning the stock market. Here’s a sampling:

  1. Cult Figures — Bill Gross
  2. Stock bulls have a beef with Bill Gross — Jonathan Burton
  3. Why Are Investors Fleeing Equities? Hint: It’s Not the Computers — Andrew Ross Sorkin
  4. Small investors vs high-speed traders — Felix Salmon

I chose these because I think they add to the discussion.  In general, I think there are a decent number of retail investors, that have left the markets, or reduced their exposure.

But I saw this back in 2002, when I saw many friends leave the stock market because of the losses they were taking.  Several said to me, “I am going to invest in what I know — I’m sticking with real estate.”  I winced and stuck with stocks, and had phenomenal performance in 2003.  I paid off my mortgage, and considered selling my house in 2005, but I realized for me, a house is not an investment — it’s a place to live.

After 2008, more people concluded the stock market was rigged.  Why?  Because they lost money, and that couldn’t be their fault.  Sorry, but retail investors, and many professionals too, give way to fear and greed, and chase trends.  They are not invested at the bottom, because they are too scared.  They are invested at the top, because it is the “thing to do if you want to make money.”

Call my point 1 this: People who don’t understand investing buy and sell at the wrong times.  They panic and get greedy.

Point 2: People don’t get that returns are lumpy.  They happen in spurts, over months, years, decades.  This is the big problem with financial planners — they assume smooth returns that will assure a retirement.  Sorry, but market moves in regimes, and is not easily predictable.  There are a few two decade periods where the market goes nowhere.  They are not anomalies; the value of companies are catching up to their prices.

Point 3: The estimates of equity outperformance sold by consultants, financial planners and naive journalists exaggerate the reality.  Here’s the reality: equities perform maybe 1% better than Baa/BBB bonds, particularly when you analyze the investments on a dollar-weighted basis.

Point 4: Everyone loves a winner.  People were spoiled by the returns of the 80s and 90s, and that validated in their minds the idea that more stocks are better; the projections of the financial planners are conservative; equities always beat bonds.

Point 5: Most ignore long-term valuation metrics, whether professionals or retail.  Whether it is the:

  • Q-Ratio
  • CAPE
  • Price-to-Resources Ratio
  • Whatever John Hussman has cooked up
  • Eddy Elfenbein’s view the stock market as a bond measure

they say roughly the same thing at present: equities are overvalued long-term.  Short-term is another matter: P/Es aren’t that high and momentum is running.  But how short is your horizon?  This makes sense if you are willing to play for months, not years.

Point 6: Professionals changed too.  In this market environment many professionals have started to trade more, as if we don’t trade too much already, and I think this is the wrong response.  As professionals, we need to do due diligence, and pick stocks we can be happy with for some time.  High frequency trading affects those who are not clever at trading.  Those who are clever disguise their trades making them look small like retail.

Point 7: But regardless of who holds stocks, they are still held by some entity.  They don’t disappear.  They move from weak hands to strong hands.  The trouble for retail investors is that they are weak hands on average.  They can’t handle disappointment, versus value investors who buy when there is disappointment.

Yes, I understand the frustration of average investors who do not do well; you are novices in a complex market.  Maybe you should just buy BBB bonds.  With the abnormal economic policies of our government, it is difficult to make any decision.

Personally I don’t think that retail investors are abnormally disappointed at present.  This is just market noise — we face overvaluation, but positive momentum.

Me?  I keep owning undervalued companies for myself and clients.


  • Based on Shiller PE, I think we can expect only about a 3.5-4% return on equities for the next 20 years. When TLT is yielding 2.8% on an average maturity of 25 years or something, that’s a pretty small spread.

    I don’t think buying equities in bulk as an investment is a good idea right now. The masses are, for once, right to be gun-shy. Normally a 3+ year bull market would have them frothing to buy, so this shows surprisingly good judgement.

  • bbarberayr says:


    the thing I have a really tough time understanding is why is it that bottom up value investors like you and I and many other very successful ones are seeming to have no trouble finding undervalued stocks, yet the top down guys like Hussman say stocks are in the 0.6% most expensive period.

    I wonder if longer term metrics like CAPE were not thrown off by the financial crisis and the corresponding huge writedowns.

  • maynardGkeynes says:

    Even if a stock is “undervalued” today by some objective measure, that doesn’t mean it’s a good value. FED policy has distorted equity valuations every bit as much as bond valuations (look at what’s happened to dividend stocks). Equities are a close substitute to bonds, and when the price of the primary good goes up, so does that of its substitutes. On a risk adjusted basis, all returns have been artificially repressed to the same degree, and there is no way around that, except perhaps to wait and stay in cash until a more opportune time. Unfortunately, it’s hard make clients happy by telling them to stay in cash, which is why so few practitioners bother to do so anymore.

  • RichL says:

    I’m deeply involved in markets, and am a retired professional investor who traded upstairs and on the floor. Retail orders are now executed when it suits the dealer community. I had a preferred stock trade at 117 3/4 and 117 1/2 in decent size, and after 20 minutes the market got around to executing my offer at 117 for a NYSE listed name. I watch my bids and offers in small stocks trade .0001 higher or lower than my order constantly. At the close today I had a bid to buy 500 shares of a small stock at 3.35- after the order was entered the stock traded at 3.35 for 100 shares, and 212 shares at 3.30- NOTHING DONE.

    Stocks are the best game in town for investment, but it is rather hard to get a fair shake when retail orders get to be the pinata, rather than have priority as existed before.

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