A certain investor has said that his investment philosophy is to “attempt to be fearful when others are greedy and to be greedy only when others are fearful.” Trite sounding, maybe, but since the investor is Warren Buffett, it's worthwhile considering. His simple language suggests that too many people buy and sell stocks based on emotion, and that when they do, often do the wrong thing.
Recent history is instructive. Go back to the end of 1999, when the country was buzzing with excitement over the fast money created by the stock market. 1999 had been a banner year — the Dow Jones Industrials and the S&P 500 were up 25.2 percent and 19.5 percent, respectively, in a record fifth consecutive year of double-digit gains. The Nasdaq Composite had gone up an eye-popping 85.6 percent, the biggest ever annual gain for a major U.S. market index.
Even people who were not usual participants in the stock market were talking about stocks, and everyone wanted in. As CNN Money reported at the end of 1999:
“In taxis, restaurants and offices across America, people talk about stocks with the same passion as they talk about their favorite baseball team or the latest episode of a hot TV sitcom. Wall Street experts such as Abby Joseph Cohen, Ralph Acampora and Peter Lynch have become household names. And when Fed chairman Greenspan crosses a Washington street on the day of a crucial meeting on interest rates, all eyes turn to his briefcase ...”
Empirical data from 2000 appear to confirm that individual investors were turned on to stocks. In 2000, a record amount of money had flowed into stock mutual funds (on a net basis, meaning purchases minus redemptions). Although stock mutual funds own only about 20 percent of stocks in the U.S. markets today, they are considered a bellwether of sentiment of individual investors, who typically own stocks through mutual funds instead of outright. So the fact that money was flowing into stock mutual funds suggests that small investors were buying stocks.
But did all that good feeling and excitement — greed, using Buffet's terminology — make it a good time to enter the stock market? In retrospect, no — as everyone now knows, the stock market did not perform well in the early 2000s. The Dow and the S&P 500 have only recently recovered the ground lost since 2000, while the Nasdaq is still about 40 percent lower than its March 2000 peak.
While the market performed poorly from 2000 to 2002, net stock mutual fund flows were positive the whole time, meaning that individual investors continued to buy stock mutual funds more than redeem them. This trend continued for most of the decade, and market returns were positive through 2007.
Then something changed in 2008; that year, in the stock sell-off during what some now call the Great Recession, investors were heavy net redeemers of stock mutual funds. And despite the solid stock market returns of 2009 to date, investors have remained net redeemers of stock mutual funds. Why?
Ask a group of people why they avoid the stock market, and their answers run the gamut: Europe, the presidential election, the fiscal cliff, the deficit, slowing growth in China, the stock market has rallied too much, to name a few. Their long list of reasons for being pessimistic, many contradictory, sounds a lot like fear. And as those people have stayed on the sidelines watching the stock market's advance, someone else has evidently been doing pretty well.
Ian Ogilvie works for a financial services company in Oklahoma City. His column appears here occasionally.