The Second Dumbest Kind of Money is Pouring Into Stocks – “With a Vengeance”
One of the traditional signs of market tops is when individual investors finally succumb to the lure of apparently easy money and pour their savings into the stock market. In the past this dumb money flowed into equity mutual funds in general, but today it’s favouring exchange-traded funds (ETFs) that, rather than trying to pick winners, simply offer exposure to sectors or broad market indexes.
This is a sign of a market top, because small investors tend to trade on emotion rather than logic or expertise. It takes them a long time to forget the pain of the last bear market, so they avoid the early stages of recoveries. When they finally conclude that there’s money to be made, it’s usually too late.
Individual investors are the second-dumbest money because governments are even less astute and more emotional than individuals, and their plunge into equities is just beginning. Japan’s central bank is now one of its market’s biggest ‘investors,’ while the Swiss National Bank is a huge holder of blue chips like Apple and Microsoft.
In the next downturn—which seems imminent—the US Fed and European Central Bank will find that interest rates are too low for further cuts, while the supply of bonds is insufficient for new QE programs. So they’ll join Japan and Switzerland in buying stocks. They’ll do so indiscriminately, creating their own index ETFs and throwing money at a broad range of large cap stocks, possibly pushing prices to levels that history would consider insane. In other words, they’ll act like retail investors on steroids.
But that’s a story for the next cycle. This time around the fact that individuals are pouring in is all we need to know.