As usual, herd investors make the biggest inflows near peaks and the biggest outflows near bottoms. The biggest monthly inflow in history was in February 2000 and the largest monthly outflow was in February 2009, which speaks for itself. Such investors only tend to participate in bull markets after most of the gains have already been achieved, and they only bail out of bear markets after most of the losses have already been suffered.
When average investors feel confident that they will not lose money on a popular investment, then it is far more likely that they will lose significantly in that asset. This irony plays out because millions of other people will have reached an identical conclusion. These millions will, therefore, have poured into highly risky assets and thereby cause prices to become even more illogically inflated near peaks, such as we have been experiencing in 2014. These days such herd mentality investors are replicating this illogical pattern in the U.S. equity markets. Interestingly, they are doing the exact opposite of what took place in 1981-1982, when investors refused to buy stocks, bonds, or real estate at incredible bargains because they could earn 13% in a three month term deposit and their money was very safe with the bank, and for that time period. In 2014, we have millions of people buying stocks and high yielding, risky junk bonds at the top of the market for one reason: they have been unhappy with their returns of less than one percent in a safe bank account.
A recent example of this illogical behavior can be seen in investment patterns at the end of July and in early August of 2014. VIX (Volatility Index) shot up quickly, responding to a pullback for U.S. stock indexes. This was an indication that most investors were confused about why all their so called “safe and steady” stocks and ETFs, suddenly changed course. Now that U.S. stocks have recovered most of their losses and VIX slid down to 11.89 on Friday morning, investors have prematurely concluded that they should continue to buy on dips and assume that the risk of a bear market is very low. We beg to differ with such a conclusion.
‘There is no “slam-dunk” explanation for these high valuations’ said Robert Schiller in his recent comment on Marketwatch. Read Robert Shiller’s thoughts on why this bull market cannot possibly keep going.