The never ending story… return of the herd…

By Filipe R. Costa.

Is it really any surprise that mutual funds are luring private investors back into the market at a greater rate than at any point in the last 12 years? After all, this is approaching the top of the market. Of course retail investors are piling back in!

People never learn.

Unlike the mania at the end of the last Century, the latest move by the retail herd is a deliberate result of central policy planning. And it could turn out to be one of the most disastrous policy missteps ever made. With generally unattractive yields on “safe” investments, such as bonds, and no end in sight to QE4EVA, it is understandable why so many appear sucked into the notion of a never-ending bull market.

So far in 2013 stock mutual funds have attracted $172billion. This is second only to the $272billion raised in 2000. Yes! 2000!!!!!

This new trend is in direct contrast to the period of 2009 to 2012, during which private investors put their money into fixed income investments. And yes, they missed the triple digit gains in the S&P500 in the process! Again, from a collective point of view, this attitude is somewhat understandable. There was a flight to safety after the crash of 2008/09.

Perhaps the current bull market still has legs. Who knows, we could even see a euphoric 2014?

However, getting into the market at this stage is playing with fire. The further indices pull away from their long term averages the harder the fall will be, when it eventually comes.

To illustrate further the risks, private investors have currently allocated 57% of their portfolios to equity markets. This is a record level. Only on two previous occasions has a similar proportion been witnessed; once again in the late 1990s and in the 2007-2009 pre-crisis period. (Notice a theme developing here?!) Both of these periods were characterised by excessively optimistic attitudes and we all know what immediately followed.

In the words of one financial advisor “People seem to realise that if they want their money to grow they have to be willing to take more risk”. This is a partial truth, but fails to explain what is behind this move. It is not exactly like people with capital have much of a choice. They are being forced down this path by the Federal Reserve, who is blocking all other serious investment routes, by keeping interest rates so artificially low;

Since the late 1990s interest rates have been so low that pension funds and other risk-averse/capital preservation funds have been obliged to take on extra risk, just to survive. The Federal Reserve has massively exacerbated the situation through its interest rate policies over the last decade. This has directly led to a serious misallocation of capital. At some point this situation will have to resolve itself through a serious correction. In the 1990s, the euphoric buying of stocks was called “irrational exuberance”. What is it called today? “Policy induced suicide?”