I noted in a blog recently that the problem with a high commitment to stocks, equity ETF’s or mutual funds by retail investors is that they are traditionally wrong at market extremes. In other words, retail investors tend to hold more stocks at the top, and hold less stocks at the bottom. Retail investors are currently holding too much of their portfolios in stocks. You can see this on the chart below, courtesy of www.sentimentrader.com. I’ve circled areas of extreme levels for stock allocation going back to 1999. The bottom of the chart shows us periods where stocks were “under-owned” by retail investors. Note how those low levels of stock ownership line up nicely with market bottoms- which I’ve marked on the S&P500 line with arrows. The top levels of stock ownership were also circled on the chart. Note how market tops – both minor tops and major tops – tend to coincide with retail investors loving stocks – also marked with arrows. As you will note on the chart, the level of total stock ownership by retail investors is just getting into the danger zone. Keep in mind that this is a big-picture signal. As such, it doesn’t tend to give you precise buy or sell date signals. Selling or buying decisions on these signals should be refined by traditional technical analysis signals.
One of the reasons behind retail investors enthusiasm towards equity ownership is the “NOA” theory. That is, with interest rates being so low, investors have No Other Alternative than to invest in risky assets (stocks, ETF’s, mutual funds). This is a flawed strategy that retail investors (and their advisors) often play out when interest rates are “too low” on fixed income securities. They don’t like the 2% yield on short term GIC’s or bonds, so they justify buying growth or dividend paying stocks or related products instead. A hot stock market entices investors to move out of low yielding bonds and move into the stock market in search of higher returns. Investors become so fixated on chasing a higher return that they don’t think about the increased risk to their portfolio inherent in doing this. The “Great Recession” of 2008/2009 woke a few investors and their advisors up to the realities of replacing low risk securities with equities in order to chase returns.
I believe that this particular mindset probably doesn’t apply to the readers of this blog. I believe that you, as a reader of this blog, have a very strong sense of market risk, and an equally keen desire to avoid it. As such, you read this blog – and do your own research – in order to sidestep the crowd when things get frothy.
Given the frothy behavior by retail investors at this point, one might make a greater case than normal to “Sell in May and go away” in the coming weeks.