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Are Retail Investors Heading For The Exit?

November 27, 2017 Blog

Retail investors who have recovered most of their losses from the 2008 financial crisis seem to be getting skittish about the market.

According to The Wall Street Journal, investors pulled money out of junk-bond funds at a near record pace over the past week. Net flows from high-yield bond funds jumped to $6.7 billion in the week ended Nov. 15, according to strategists from Bank of America Merrill Lynch. That was the third highest outflow on record, the bank said.

“The recent junk bond selloff put investors on high alert, given that a sustained retreat could herald the first crack in a strong 2017 market rally that has taken major global stock indexes to record highs,” according to the Journal. “Some analysts are particularly concerned that retail investors, whose exposure to junk bonds tends to come through passive funds, may get spooked by the market weakness and pull out more money.”

There could be other cracks in the historic bull market, which began its run in March 2009 after the credit crisis had nearly destroyed the economy and decimated the savings of millions of Americans. The S&P 500 is up 280% since then, and some observers have been watching for the next bear market.

One potential risk is exchange traded funds, or ETFs. Mom and Pop retail investors are heavily invested in ETFs, which are attractive due to their relatively low fees. Market observers have seen recent “huge outflows” from junk-bond ETFs and mutual funds held by retail investors, according to the Journal.

ETFs in particular pose hidden dangers for the market. They could be increasing stock volatility and could lead to a huge stock drop should investors dump them at the first sign of a stock correction.

The funds “have gotten too big for their own good, making them an unappreciated risk in the event of a market decline,” according to a recent MarketWatch report. “The popularity of such funds has raised concerns about what the fallout of this trend could be. Essentially, the fear is that if a stock’s shares outstanding are concentrated within ETFs, its daily moves will be dictated more by the buying and selling of the funds, rather than by the company’s own fundamentals.”

The rise of ETFs “into a multi-trillion-dollar segment of the global financial system is one of the most consequential economic developments of the past 30 years,” according to the report.

In other words, if Mom and Pop investors get scared and dump more junk-bond ETFs, that selling could cascade and do greater damage to securities issued by individual companies. It’s potentially a vicious circle.

Stay tuned….

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