So-called 'dumb money' can be a good guide to market turning points.
Sentiment both drives markets and indicates turning points.
Bull market peaks are characterised by naïve retail investors piling in to the markets, desperate to join in the profits headlined daily by the popular press. Similarly at market bottoms, the retail investor usually pulls funds out of the markets just before they turn. This unfortunate human trait has led to retail investors' funds being labelled 'dumb money'. I've taken a look at some of the statistics to take a look at whether the moniker is fair, or unfair.
Retail investors are prone to crowd behaviour
The Investment Management Association, the trade body for fund managers, publishes monthly, quarterly and annual statistics relating to individual and institutional fund buying and selling. It is therefore a pretty good guide to sentiment.
When the dotcom boom was in full flow, sales of funds to retail investors soared. In 1999, as the FTSE approached 7,000, they bought £8.3 billion. In 2000, just in time to catch the start of the savage bear market, they pumped in £14.5 billion, guaranteeing the largest chunk of wealth destruction for almost a century.
Retail investments then declined to the point that in 2003, the start of the next bull market, they were a mere £2.9 billion. The next peak in equity purchases was £4.5 billion in 2006, missing three years of the bull market, and just in time to catch its last gasps, before the credit crunch hit in 2007.
As expected, in the bear year of 2008, retail investors were net sellers of equity funds, offloading no less that £1.3 billion. But what has happened so far in 2009 is really quite interesting. Some aspects confirm the dumb money hypothesis but others may indicate a generational shift in investor sentiment.
Conflicting signals from bonds and equities
Retail investors kicked off the new year by selling equities into the declining market, during January and February. But contrary to the "dumb money" hypothesis they started buying in March at the market lows -- precisely the right thing to do (so far). And at pretty high levels; £447 million in March, £583 million in April.
Just before the best quarterly return for equities in a generation, in June, retail investors once again made the right call and invested just over £1 billion – in a single month! Annualised levels like this were last seen at the fag-end of the dotcom boom.
And therein lies the problem. Have retail investors turned the "dumb money" hypothesis on its head, and got in early at the start of a bull market? Or have they been tricked into the mother of all bear market rallies?
No one knows quite yet, but there are conflicting signals. Investments in equities have been dwarfed by investments in bonds in the year to date. In the nine months to September equity investments totalled £5.3 billion, bond investments totalled £8.9 billion.
This could mean risk appetite is relatively low, there is money 'on the sidelines' and therefore there is little danger of an imminent crash. Well, it could but I rather suspect the money flooding into bonds and equities represent 'investors' (I use the quotes intentionally) fleeing near zero interest rates, desperate for a return on their savings.
Also, in September, investment in equities was 50% greater than in bond funds. So in my view that's bearish once interest rates start to rise. That may not be for another 18 months, but since markets look ahead it would be wise to be wary after the traditionally bullish months of December and January.
A shift in tactics?
But there was another, not widely reported, notable event in September. The Absolute Return Sector, unheard of a couple of years ago, was the highest selling sector, accounting for £442 million of net retail sales. In contrast the Corporate Bond sector received £324 million.
Perhaps we are seeing a scarred generation, emotionally crippled by two vicious bear markets in eight years, dismiss with scorn conventional investment approaches. And that's a trend worth watching, as will the performance of Absolute Return funds, about which I have my doubts.
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