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Are Retail Investors Signaling A Market Top?

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    July 31, 2014

    It is often stated that retail investors represent the “herd” mentality.  That, like lemmings, they tend always to do the opposite of what they should by “buying high and selling low.”  For the most part, those statements are true and have been repeatedly shown in surveys and studies over time.

    However, over the weekend as I was writing The X-Factor Weekly report, which discussed the new SEC ruling on money market mutual funds, Alan Greenspan’s ignorance and the “warning sign” from “junk bonds,” I stumbled across an interesting data point.

    “Furthermore, as I have repeatedly stated over the last several weeks – bonds are not buying the current market rally. As shown in the chart below, despite the ongoing chorus of “sell all your bonds as rates are about to rise,” money flows into bonds has been picking up steam.”

    (The following chart is data sourced from ICI which shows the flow of funds by mutual fund investors into equity mutual funds versus bond mutual funds.) I have highlighted the point at which equity flows turn negative after being positive.

    Equity-Flows-Negative-072614

    While not a “perfect” market timing indicator by any means, it is interesting is that despite claims of retail investors being “dumb money,” it appears that their actions may indeed actually lead the market. As noted, retail money flows into equity mutual funds have turned negative just prior to short and intermediate term market corrections.

    Furthermore, even as the mainstream analysts continue the “stock market rally is here-to-stay” even it “rates rise” mantras, retail investors “ain’t buyin’ it” and are upping their holdings in bond funds. The chart below shows the disparity between interest rates and the S&P 500 index.

    Interest-Rates-10YR-SP500-072814

    What is important to notice is that it is not the RISE in interest rates that impacts the markets, but the change in trend that is most notable.  (I used a 3-month average to smooth the volatility of interest rates over time) It is the “why”that is critical to understand.

    The long-term chart below of interest rates versus the S&P 500 extends that analysis. What is clearly shown is that it is when interest rates do begin to rise that it isn’t long before something “pops.”

    Interest-Rates-SP500-072814

    Interest rates are a function of real economic activity. While the stock marketshould be a rational reflection of real economic activity, the reality is that prices are driven to extremes by emotional biases. The chart below shows the long-term correlations between interest rates, economic activity and inflation.

    Interest-Rates-GDP-Inflation-072814

    Given the fact that activity has likely peaked for this current economic cycle, deflationary pressures persist (wages and monetary velocity in particular), and the tightening of monetary policy in the quarters ahead suggests that the current “bull market” in stock prices may be at risk. Furthermore, the recent decline in interest rates are suggesting that the weakness in Q1-GDP was not just a “weather related anomaly.”

    While I am not suggesting that the market is about to fall into a full blown correction, it is interesting that the despite “hard data” to the contrary, the perennially “bullish” commentators are scrambling for reasons “this time is different.” What is most curious is that it appears that the “retail” investing public may have already figured out that it is not.

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    Lance Roberts

    Lance Roberts is the General Partner and Chief Portfolio Strategist for STA Wealth Management. He is also the host of “The Lance Roberts Show,” Chief editor of the X-Factor Investment Newsletter and the Streettalklive daily blog. Follow Lance on FacebookTwitter andLinked-In

    Images: Flickr (licence attribution)

    About The Author

    Lance Roberts – Host of StreetTalk Live

    After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

    Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

    Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.

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