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When Mom and Pop Investors Join the Market Party, You Know It’s Time to Get Nervous

March 17, 2017 Blog

Last week, the bull market in stocks, which started after the financial crisis hit bottom in March 2009, reached its eight-year anniversary. It’s the second longest bull run in S&P 500 history, adding more than $14 trillion in value to the index over that time.

That’s all good news for investors, but market tops are troubling. Egged on by their stockbrokers, Mom and Pop retail investors have turned from cautious to optimistic. There’s apparently euphoria among investors joining the stock market and chasing returns.

“Investors have poured money into stocks through mutual funds and exchange-traded funds in 2017, with global equity funds posting record net inflows in the week ended March 1 based on data going back to 2000,” the Wall Street Journal recently reported.

Investors have been cautiously moving back to the market since the credit crisis and the near collapse of the global economy. But are they now getting in too deep?

“People went toe in the water, knee in the water and now many are probably above the waist for the first time,” one market strategist told the WSJ.

The broad market’s persistent rise since the election of Donald Trump as president has also worked to pull in small investors who – after sitting on the sidelines for years – are now fearful of missing out on big gains, noted the WSJ.

This is uncanny.

A glance at recent history reveals that retail investors always seem to dive in and invest at the top of the market after the so-called smart money – bankers and institutional investors – has booked handsome profits and sprinted for the exits.

Before the 2000 tech bubble, the smart money investors in high technology, internet and telecom stocks cashed out and made exorbitant profits.

Who got hammered? The little guy who jumped in at the market top and loaded up on dogs like, only to be wiped out when the bubble burst.

It happened again a few years later in 2007. Brokers told those same retail investors to buy bank preferred stocks, issued by Lehman Brothers, Bear Stearns and Merrill Lynch. The preferred shares’ juicy yields were well worth the risk, the brokers said.

We know what happened there. Lehman went bankrupt and Bear Stearns disappeared. The other banks were crushed, with the retail investor suffering their worst losses since the great depression.

And it happened again in 2014. Brokers told their Mom and Pop clients that they needed to buy oil stocks and oil Master Limited Partnerships (MLPs) as the price of oil reached $100 a barrel. How could oil ever go down?

With global production at record highs, the price of oil crashed to $20 a barrel months later and many oil producers slid into bankruptcy. The small investor was handed yet another crushing blow.

There’s good reason to believe we could be at a similar point.

With the Dow Jones Industrial Average touching the 20,000-21,000 level, the retail investor is now euphoric, according to a recent WSJ article. Some are increasing their exposure to stocks, which carry more risk, and cutting back on bonds; some are tilting their portfolio to 80% equities and 20% in bonds. The historical standard allocation is 60% stocks to 40% bonds.

This tilt towards stocks coincides with the smart money exiting at the top of the market, according to the WSJ. Those savvy investors are increasingly cautious and cashing out; corporate insiders are becoming sellers rather than buyers of their own stock.

“Corporate executives are buying their own firm’s shares at the slowest pace in at least 29 years, the latest sigh of uncertainty as the booming U.S. stock bull market this week enters its ninth year,” the WSJ reported.

Is stock market history repeating itself? We certainly hope not. But Mom and Pop investors need to fight the urge to invest heavily at the top of the market. They may get crushed again.

Zamansky LLC are investment and stock fraud attorneys representing investors in federal and state litigation and arbitration against financial institutions.