2019 has been a good year for stocks so far, but it could have been quite a bit better if not for individual investors dragging it down. JP Morgan expects this to change in 2020.
It isn’t that easy to predict where the stock market will be in a year from now, but that doesn’t mean that we can’t come up with forecasts. This really doesn’t serve any useful purpose though right now other than to perhaps provide comfort for anxious investors, or make them even more anxious, depending on the forecast, so it’s not as if there’s any sort of need for this.
What these forecasts are for are instead to better prepare us for what may be to come, helping us better distinguish the potential of a market’s change in mood and decide whether it worthy of our attention or not. If the forecast is sunny, we may be willing to give our positions time for this positive outlook to manifest. If it is expected to rain, then much less will have to fall on us to get us to go back inside.
We still cannot decide anything at the time of the forecast other than to perhaps pay closer attention to things, but the visions of what may be need to be confirmed in the present before we should ever act.
A good example would be with people’s worrying about a recession coming, and while this is possible, we need to wait until the odds make it likely and not just a matter of speculation. We need to either see these events happen before we act, because even if we know something is coming, we usually don’t know exactly when.
Looking ahead can be a useful exercise though. JP Morgan analysts have had a look at the year ahead and come out with a pretty bullish view, not so much based upon the predictions of the economy remaining stable, or the prospects of the end of the trade war with China, they are basing this more than anything on their prediction of the reversal of the outflow from investors that 2019 brought.
In spite of the market being up 25% this year, retail investors have been taking more money out of the market than they have been putting in, a lot more. This has been happening consistently all year, in both the good and bad months for the market.
This is actually a great example of how we don’t want to be paying too much attention to forecasts and the harm that can come out of it if you act on what is believed yet to come. You just can’t predict the future that well with stocks and if you act on these predictions, on what might happen over what is actually happening, you are investing badly no matter what the outcome.
This of course doesn’t affect those who have committed to their stocks for the long haul, although even these investors approach the time where they no longer have the long term left and ultimately will come against the decision to need to time their exits, and may choose to be impetuous.
Timing your exits with stocks is truly a game of skill, and while the skills required are not that substantial, they extend well beyond any whimsical approach that would even have investors considering getting out of the stock market at any point in 2019. This was both a mistake in retrospect and just as big of a mistake at the time because there wasn’t sufficient justification for it in the first place.
There may be no better evidence of this mistaken thinking in action than what has happened so far this year. 2008 was one of the worst years for the stock market, and had set the record for retail investor outflow at $209 billion. With the market crashing, it is understandable that we’d see so much money moving out of stocks, whether or not these moves proved to be handled wisely or not.
We had a stampede on our hands, and this massive outflow and the way that stock prices fell did align extremely well. This wasn’t about acting upon some future belief, this panic was fully grounded in the present, and it is hard to imagine a darker day than seeing the entire world financial industry on the brink of collapse, which we came within days of, if not for the heroic efforts of the government to save it.
A Mass Exodus During a Very Bullish Year Reveals a Big Mistake
2019, on the other hand, has been one of the best years for stocks ever, even though this 25% gain has been propped up by giving back almost this much in the final quarter of 2018. For those who made it through the rain or exited and were now looking to climb back on the horse, this rebound had the market looking quite bullish and this bullishness not only has come to pass, it has just kept going.
We’ve broken the record for outflows this year though, where amazingly enough, we even have surpassed the $209 billion of 2018 with the $215 billion of outflows year to date. With a month to go, it looks like 2019 will produce the biggest outflow in the history of the stock market, and once again, during one of the best years ever for stocks.
While this is a lot of money, it does go to show that while retail investors do contribute a significant amount to stock prices, institutional investors are powerful enough to drive the market up this much even in the face of record outflows for retail investors. However, with both sides working together, we would have had an even better year, and this is what people are looking at for 2020.
People have been talking about this reversing all year, and month after month it has continued to worsen. What seems to be propelling this divergence, or conundrum if you will, as it is generally described, is the extent that retail investors are driven by fear, whereas institutional investors at least take an objective approach to these things and will be much more prone to be patient and wait for the bears to show their faces as opposed to just fearing that they might.
To worry about a bear market coming in a year or so might seem reasonable at times, and it certainly is, like it was in 2007 for instance. Things were beginning to unravel and with all of the concern out there at the time, this would have been a very wise choice in fact.
With the market making all-time highs, and nothing all that ominous on the horizon, the picture here is completely different and the complete opposite of what we were faced with in 2007. Fear is a powerful force though, and while we never want to allow fear to influence our investing decisions, sometimes we cannot help ourselves.
We might think though that anyone who has pulled back or exited stocks may come to their senses more as their mistake gets more and more revealed over time, in the face of more and more gains, but this can be like what happens to a trader when they sell into a move too soon. While they feel the pain of their mistake, they can become more and more afraid to re-enter as things keep going up as they perceive these higher prices as involving more and more risk.
People also look to how long this bull market has been going on for and believe that the longer it goes on, the more likely a reversal is. This is a very mistaken belief though, and in fact the opposite is true, as the more positive momentum you have, the more likely it is to continue, not reverse.
This is not such a conundrum actually if you understand investor behavior, not all investors of course but the ones that are anxious and are disposed to act too defensively in seeking to protect their profits. A lot of money has been made in stocks over the last 10 years, where the average stock has more than tripled in value, and some may want to book these profits and avoid whatever nastiness that may be on the way.
It is always a mistake to sell into strength though, and while institutional investors have to do this at times to get out of their positions, they need a better reason to do this than just worry. You never want to buck the overall trend though, and they know this, and this is why they have continued to remain bullish on the market, and bullish enough to not only overcome this downward pressure from retail investors but to add on another 25% to the upside for good measure.
Retail Investors May Wake Up, but it May Take More than Time
The thinking out there now is that these retail investors have to wake up sometime, and after running away for all of 2019, 2020 should be different.
The first thing that we need for this prediction to be valid is that the strength of the market that we have seen in 2019 be maintained, and if not, this will only serve to accelerate retail investor outflows. This will not only encourage more people to do this, it will instill a sense of vindication among those who have already chosen this path.
This would also involve a healthy sense of rationalization, as investors tend to be prone to, where they may even see things like missing out on 20% on the upside and then avoiding a 10% pullback as a smart move, even though this still leaves them down by 10% overall.
It does hurt a little more to lose money than it hurts to lose opportunities, and for instance a 10% loss when you are in stocks will outweigh a 10% gain in them without us. The real difference between them isn’t that great and especially for investors who can handle much bigger drawdowns than this and still stay in their positions, and exiting at a loss is the only risk here.
We misunderstand this though and place far too big of a weighting on avoiding the losses where we should be much more focused on the net result. Institutions, on the other hand, take a more sensible and balanced approach to this, and while we definitely should be looking to manage risk, we don’t want to do this to the extent that we significantly reduce our overall expectation, like investing in bonds over stocks does when stocks are moving forward.
The outlook for 2020 independent of looking at investor behavior remains positive, and the all-time highs that we are seeing demonstrate this. We do have to worry about how the 2020 presidential election is going to affect things, and that does not look so good right now, but that’s a year away and there are some good times forecast until we at least get a clearer picture of how this election may play out and how it may limit the growth of stocks.
Nikolaos Panigirtzoglou of JP Morgan believes that this reversal in mood by retail investors will indeed come to pass next year. “Given this year proved to be a strong year for equity markets, helped by institutional investors, then we should see retail investors responding to this year’s equity market strength by turning [into] big buyers of equity funds in 2020. This suggests 2020 could be another strong year for equities driven by retail rather than institutional investors.”
We could have said that throughout 2019 as well, so we need to ask what will really be different in 2020. There is certainly a chance that one day they will just wake up and realize how much money that they have missed out on, and once again, missed money from being out really is as bad as lost money while in, or close enough to it for investors that we should treat it the same way, but that’s not how a lot of people see this.
More progress on the trade front would be a reason that may indeed influence this trend, as would getting more and more comfortable that a recession is not on the horizon. It doesn’t take much to scare these investors as they are swayed by things that aren’t even meaningful to stocks such as a bullish bond market.
The bond market has been very bullish over the last year, but stocks have been as well, and therefore the worry that this might bring down stocks is factually untrue and therefore can be simply ignored. As a matter of fact, when bonds are this hot and stocks are as well, this speaks even more to the strength of the stock market.
Retail investors have put a lot of money in bond funds over the last year though, and this has been behind a lot of the migration away from stocks. Bonds have recently turned bearish though, and as this continues, seeing bonds lose in value while stocks continue to rise in value can be relied on a lot more to produce a reversal of these outflows than just time alone.
We still need to worry about the election though, and worry quite a bit in fact, and this looks very likely to finally mark the end of the bull market in stocks that we have enjoyed since 2009. When this risk does materialize enough, you can bet that institutional investors will join retail investors in pulling out, and this is when the bear starts to show its face.
In the meantime, retail investors would be far better off if they just sought to follow the big money, both when the market goes up and when it goes down. All the selling that retail investors have done in 2019 speaks loudly to how big of a mistake it can be to try to buck the overall trend.