Investors' Fear of Flying
WHY YOU SHOULD CARE
The stock market is going crazy again. So where’s the exuberance from U.S. investors to match? Chalk it up to more than one mental block.
By Chris Pummer
For U.S. stock investors, 2013 saw the Dow and S&P 500 rack up a series of all-time highs on their way to the most enriching annual gains in more than 15 years.
As those stock indexes flirt with further record highs in 2014, Wall Street analysts are trying to deduce the “resistance level” at which they’ll peak next before tumbling back down. But what analysts’ numeric models and myriad calculations can’t gauge is the nature of the resistance.
Investors are haunted by the recent memory of two of the worst crashes since 1929, and they are showing signs of being twice bitten, thrice shy. They ran the Dow up by 27 percent and the S&P 500 by 30 percent in 2013, but that corresponded with the housing market’s resurgence and a re-inflation in owner equity, not coincidentally. And now, the exuberance that generally accompanies market highs and the begetting of new ones is distinctly absent.
The average investor right now is at best very cautiously optimistic…
“A new high typically creates buying in and of itself, for no other reason than people who shorted a stock [betting its price would fall] have to buy shares to cover their bets, so no one’s in pain except for the shorts,” says Denise Shull, a neuroeconomist, founder of The ReThink Group consulting firm and author of Market Mind Games.
“The drama that occurred after 2008 with so many people losing their jobs and homes, and the bank bailouts was an unbelievable crisis that’s still in the back of everyone’s mind,” Shull says. “The average investor right now is at best very cautiously optimistic, primarily because the economy remains a question mark.”
The thrashing baby boomers took on retirement portfolios twice since 2000 has also made many of them reluctant to put at risk a lifetime of accumulated assets that they’ll soon need to draw on for the remainder of their lives.
“I don’t think we’re approaching a market top because there’s still a massive number of people and money on the sidelines [in conservative fixed-income investments],” says Michael Pompian, a partner at Mercer Hammond Investment Consulting and author of Behavioral Finance and Wealth Management. “Those who haven’t participated in the bull market since 2009 may be questioning if they’re getting in too late.”
Making the same market information available to all parties doesn’t level the playing field.
Add to that small investors’ growing realization that the preponderance of online information at their fingertips, which triggered the day-trading phenomenon, doesn’t equip them to play in the same league with the pros if they can’t fully decipher its meaning.
“Making the same information available to all parties (as the Sarbanes-Oxley Act did after the 2000 crash) doesn’t level the playing field,” says Terry Odean, finance professor at the University of California’s Haas School of Business. “If you give the average investor all the data for a company, can they do the same fundamental analysis as a guy who went through a Ph.D. program and works at Goldman Sachs? It’s just an illusion of a level field.”
The global stock market, without question, is the nearest expression of a mass mind outside of science fiction. Millions of trades, and the individual thought processes that drive each, collectively determine a stock index’s “closing number.” When the financial media attributes daily movements to one or a few factors—a surprising economic report, an industry leader’s profit leap, an international conflagration—it’s grasping at straws in a vain attempt to address the “Why?”
They tend to over-predict reversals when markets have been doing extremely well…
What is clear is that countless older Americans have seen retirement dreams forestalled by eviscerated 401(K)s and IRAs and the belief that their inflated home equity would be harvestable. Meanwhile, after witnessing the rich get remarkably richer, they sense that the investor protections imposed on Wall Street may be scaled back if a Republican wins the presidency in 2016.
“They tend to over-predict reversals when markets have been doing extremely well,” Shefrin says. “It’s like being at a craps table and 7 and 11 hasn’t come up so you think it’s due, or flipping a coin and heads comes up five times in a row. We may know intellectually that each toss is 50-50, but emotionally we behave differently, and it’s a big effect.”
What ultimately may trigger widespread investor confidence and potentially over-exuberance, Shull says, would be the tech-stock-laden NASDAQ ascending to its record high of 5,048—set 14 years ago this month. The index would need to rise another 18 percent before eclipsing that mark.
“There’s almost a boredom with new highs [on the Dow and S&P 500] because we’ve been hitting them for more than a year,” Shull says. “The NASDAQ is full of so many names people recognize, Apple and Google, and its hitting a new high after so many years will be big news and draw small investors in.”
Shull is fairly sure of one thing—when the market will next peak. “When people stop hating the big banks as if all’s forgiven, we’ll probably be near this market top.”
- Chris Pummer, OZY Author Contact Chris Pummer