Sy Harding: It is normal and understandable that investor confidence grows as paper profits in a long rally or bull market pile up. It’s therefore normal and inevitable that investor sentiment will be at its most bullish for that cycle by the time a rally or bull market tops out.
However, it is also true that as the old Wall Street legend goes, ‘They don’t ring a bell at the top’. So how can investors who want to avoid the next meltdown, and have told themselves that this time they will, know when it’s time to act?
Since they don’t ring a bell at tops for either public investors or for so-called ‘smart money’ corporate insiders, institutional investors, and billionaire hedge-fund managers, the data shows that the latter begin to sell when they consider risk has become too high, selling on the way up. They even use the degree of public investor sentiment as one of their tools in determining when risk becomes too high, along with valuation levels, and other factors.
Meanwhile, most market technicians tend to buy on the way down, but hopefully very near the top. Most use trend-following strategies, such as the breaking of support levels as a guide. So they also tend to be bullish and fully invested at market tops, but have an exit strategy that will hopefully get them out without giving too much back.
However, history shows the majority of public investors do not seem to have any strategy at all, for getting out – or back in.
As a result, the data shows a repeating pattern of public investors coming into the market very timidly and late in bull markets, pouring increasing amounts of money in as their confidence grows, and then being hammered by the bear markets.
As the Vice-President of the Securities Investor Protection Corporation (SIPC) said in 2001, “We have been at this for over 50 years, and see the same problem over and over again. Investors are enticed in during bull markets, but then don’t know what to do when things turn sour later.”
The Investment Company Institute published this graph in 2009. It shows how investors not only poured more money into stock mutual funds and etf’s in 2000, as the severe 2000-2002 bear market began, but continued to do so at a then record pace in 2001, even as the market plunged still further in the second year of that bear market, apparently ‘buying the dips’.
It was not until after the bear market ended that they pulled money out of the market, in 2002, 2003, and 2004, missing the first three years of the 2002-2007 bull market.