December 8, 2023

Small Investors Recalibrate After Market Gyrations

After the market rout of 2008 that drastically shrank their retirement nest eggs, small investors withdrew hundreds of billions of dollars from American stock funds, and they kept bolting as the market rebounded sharply for much of last year.

But earlier this year, having missed out on last year’s gains, some investors began to tiptoe back in. The timing for those people was off, and now they are being buffeted by the steep drops on Wall Street or bailing altogether. Still others who have been holding on in recent years have had enough.

Lin Hersh, a 61-year-old small-business owner in Bearsville, N.Y., about two hours north of New York City, called up her stock broker two weeks ago and gave the order to sell everything.

She dumped nearly all of her individual equities and her stock mutual funds, moving almost completely into cash. Ms. Hersh is haunted by the market plunge of 2008, when her $432,000 in savings dwindled to $150,000.

“What I’ve got left after the last downturn is about a third of what I started out with and I’m not in the mood to play anymore,” she said. Pointing to the weak American economy and concerns about Europe, Ms. Hersh said she would most likely steer clear of stocks through the end of this year.

“I don’t think there’s a reason to buy on the dip because the dip isn’t done,” she added.

Small investors provide the bedrock for the United States stock market through their mutual funds, 401(k) plans and other company-sponsored retirement programs. Many have called their stock brokers and financial advisers in recent days, seeking advice or reassurance that their retirements and savings would survive the dives.

The vast majority of small investors have a long-term strategy and are sitting tight. They are not dumping their stocks or mutual funds and, in many cases, continue to pump money into their retirement accounts through employer-sponsored investment plans.

But even before the latest market turmoil, some investors began to look for the exit doors. More than $10 billion was pulled from domestic stock funds in the week that ended Aug. 3, according to the Investment Company Institute. Those levels are double what they were in early July.

And Charles Biderman, the chief executive of TrimTabs Investment Research, estimated that investors probably pulled out another $9 billion this week while the market gyrated wildly.

Just in the last six trading sessions, the whiplash in the Dow Jones industrial average has included three days of either 500-plus or 600-plus dives and two leaps of more than 400 points. Since the beginning of August, the broader Standard Poor’s 500-index has lost 8.8 percent.

Many investors expect continued troubles for stocks. An online survey of investor sentiment this week by the American Association of Individual Investors said that 44 percent of respondents were bearish, expecting the stock market to fall further over the next six months. While that was actually improved from the prior week, it remains well above the survey’s historical bearish readings of about 30 percent.

When it comes to domestic stock funds, which manage $4.4 trillion in assets, there have been many more bears than bulls. Those mutual funds have had four consecutive years of outflows, with investors redeeming $448 billion and putting in $104 billion, according to the Investment Company Institute.

In contrast with these longer-term investors, rapid traders have been keen on gambling as Wall Street gyrates.

TD Ameritrade, the online brokerage firm, reported that trading volumes soared into record territory this week as investors clattered and clicked away on their computers. On Monday, when the stock market fell over 600 points, TD Ameritrade processed 900,000 trades, up from an average of 365,000.

“We’re seeing a lot of new accounts opening and new asset inflows. People are looking for a bottom,” said Nicole Sherrod, a managing director of the trader group at TD Ameritrade. “But for people who stayed in the markets and stayed long, are we seeing some of them exit some positions? Yes. Absolutely.”

After years of underperformance or losses, some investors are questioning whether the long-term outlook that has been drilled into them by Wall Street financial advisers and professionals is really the best advice.

“My wife followed the advice of a financial adviser and she would have been better off putting her money under the mattress. They did nothing but lose money for her over 20 years,” said Adam Corson-Finnerty, a 67-year-old fund-raiser for the New Jersey Audubon.

Mr. Corson-Finnerty pulled his entire $500,000 retirement account out of the stock market at its peak in 2007 and put it into United States Treasuries and money-market funds.

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Fundamentally: A Bounce Isn’t Enough to Recover From a Bubble

DESPITE recent volatility in global markets, domestic stocks have doubled in value in the last two years, the fastest such gain since the Great Depression.

And financial shares have fared even better, soaring more than 160 percent since the long stock rally began in March 2009.

But will the broad market in general and financial stocks in particular resume this torrid pace? Perhaps not.

Consider how stocks have fared over a much longer stretch — since the end of the previous bull market, in March 2000. Last Thursday was the 11th anniversary of the bursting of the technology bubble, a reminder of how long it may take investments at the center of a major market plunge to return to their past glory.

For example, though most sectors of the Standard Poor’s 500-stock index are now trading above their levels of March 2000, the overall index is still slightly below where it was then. And technology and telecommunications stocks — the market’s best performers leading up to the 2000-02 bear market — are still down around 60 percent, on average, from their peaks 11 years ago; blue-chip growth stocks are off about 35 percent.

What’s the moral of this story? Don’t count on a complete recovery anytime soon, said Sam Stovall, chief investment strategist at Standard Poor’s Equity Research. “It could take 15 years for stocks to work off the effects of a major bubble,” he said.

Mr. Stovall has studied market recovery periods in the years after World War II. He has found that while it usually takes stocks about 14 months to return to previous highs after a mild bear market, and five years, on average, to bounce back from a severe downturn of 40 percent or more, it typically takes even longer to recover from a bubble.

He noted, for example, that after oil prices peaked during the energy bubble in 1980, it took 16 years for some categories of oil-related stocks to recover to their pre-bubble highs. And after gold peaked in 1980 at around $850 an ounce, it took 28 years for the price to return to their pre-bust perch. (Of course, even at $1,426 an ounce, gold still hasn’t recovered to its 1980 levels when adjusted for inflation.)

The reason that recoveries take so long “is that a true bubble occurs only when valuations are taken to extremes, and it usually requires at least two bear markets to bring those valuations back to historic norms,” said James B. Stack, editor of the InvesTech Market Analyst newsletter.

To be sure, one could argue that the valuations of financial shares have never skyrocketed the way those of tech shares did in the late 1990s.

In fact, at the end of 2007, when the global credit bubble had popped, the price-to-earnings ratio for financial stocks stood at around 17, according to Bloomberg. That’s about on par with valuations for the broad market at the time.

Yet that happened because the reported profits of financial companies had soared leading up to the plunge, Mr. Stack said, so that earnings — the “E” in the P/E ratio — generally kept pace with rising prices.

“But in reality,” he said, “many of those earnings were built on artificial sources of income that were not only going to dry up but reversed course when the asset bubble popped.”

Another reason to believe that financials may soon hit a ceiling, Mr. Stack said, is that “there are still too many people waiting to get out” of those shares. In other words, many investors are still holding onto financial stocks not out of faith, but because those shares are still so far below their October 2007 peaks — about 50 percent, on average — that they’ve have been waiting for a bigger rally before selling.

Haven’t financials surged over the last two years? Yes. But Jack A. Ablin, chief investment officer at Harris Private Bank, notes that since the first three months of this rally — when financial stocks bounced back the most — these shares have actually lagged behind the broad market. Since the start of June 2009, the S. P. 500 has gained 42 percent, versus just 34 percent for the financial stocks in the index.

Mr. Ablin said that “conditions during this stretch couldn’t have been any better for the banks,” alluding to the government’s efforts to keep short-term interest rates near zero, assuring substantial profits when banks relend that money to customers. “Yet this is all we got to show for it,” he said. “That would suggest that it could take many years for the fundamentals of this sector to recover.”

AS for the broad market, it’s hard to imagine how much longer it can keep up the pace of the last two years, some market strategists say.

Beyond the threat of rising inflation, as well as various geopolitical risks, valuations are becoming stretched. David R. Kotok, chief investment officer at Cumberland Advisors, says a simple way to judge the frothiness of the market is to consider the ratio of total domestic stock market capitalization to gross domestic product. “History says that when stock market capitalization is about 55 percent or 60 percent of G.D.P., stocks are a great bargain, which was the case during the March 2009 lows,” Mr. Kotok said. “But when stocks are 110 percent of G.D.P., it’s time to sell.”

Today, the stock market is worth about 95 percent of G.D.P. “So,” he said, “I don’t believe the market has a large strategic move upward from here in the short term.”

Paul J. Lim is a senior editor at Money magazine. E-mail:

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