August 31, 2015

Retail investors likely to invest less money going forward

....It appears increasingly likely that after a series of body blows over the last few months (or really the last few years), individual investors will likely lose interest in the U.S. stock market for some time to come.

The possibility of deeper domestic economic pain and disappointment also seems more likely than most expect.

Monday's Flash Crash

One observer described Monday morning's market opening (in which the Dow industrials dropped by a quick 1,100 points) as "the simultaneous flash crash of over 1,000 stocks and exchange traded funds."

And as I mentioned above, it had the look of capitulation to me.

Here are some of the ETFs that broke down yesterday morning on the open:

-    The First Trust Dow Jones Internet ETF (FDN), First Trust Consumer Discretionary AlphaDEX ETF(FXD), iShares Global Healthcare ETF (IXJ) and others all lost more than 40% of their value.

-    The SPDR S&P Dividend ETF (SDY), Vanguard Dividend Appreciation ETF (VIG) and PowerShares DWA Momentum ETF (PDP) were among those that gave up 30 to 40%.

-    The PowerShares High Yield Equity Dividend Achievers ETF (PEY), Vanguard Small-Cap Growth ETF (VBK), the iShares Core S&P 500 (IVV) and others shed 20% to 30%.

The disorder wasn't confined to thinly traded ETFs and individual stocks. For example,  General Electric (GE) -- a $250 billion market-cap stock that trades over $2 billion of volume day -- lost 21% of its value on yesterday's opening:

 Nor was Monday's flash crash the first event of its kind that has the potential to alienate retail investors. There was, most conspicuously, the "Big Flash Crash" of May 2010.

There have also been some other powerfully disruptive events that could disaffect small investors for years, including:

-    The Ongoing Bear Market. The past week's market schmeissings had already been preceded by a devastating bear market in commodities-based and cyclical companies (especially energy-related ones). Big Oil and others hit by this bear market are often mainstays in retail investors' accounts. That's one strike against the individual investor.

-    A Broken Market Mechanism. A second strike, as I've written before, is that the market's mechanism has been virtually destroyed (as reflected in yesterday's flash crash) by increased and more-costly regulatory burdens. These serve to limit dealer inventories in numerous asset classes and impair market liquidity, creating a vacuum that's taken up by leveraged ETFs and high-frequency-trading strategies. Basel III and Dodd-Frank (two of the major culprits) are here to stay, so this won't change. Unfortunately, violent moves in a market without memory from day to day won't boost retailer investors' confidence. 

-    Weak Political, Fiscal and Monetary-Policy Leadership. A third strike facing retail investors is the lack of confidence in our political leaders -- and, increasingly, in the Federal Reserve. I can't see that improving much over the next year or two.

-    Demographic Headwinds. A fourth strike against individual investors (as if three weren't enough for an out) is our aging population, which reduces the demand for risky assets like stocks.

But as Los Angeles Dodgers' Hall of Fame pitcher Sandy Koufax (my cousin) would say, there are many more hard-to-hit fast balls being thrown at both the U.S. consumer and retail investor.

Slowing Consumption Ahead?
First, a period of slowing consumer consumption could lie ahead. 

The average Joe has already been victimized by so-called "screwflation," in which wages have stagnated but the costs of life's necessities have increased. The typical U.S. consumer has also been hurt by monetary policy that hits members of the "savings class" (many of whom are also individual stock investors).

On top of that, home prices and rents are well above levels of only a few years ago, hitting consumer pocketbooks. Add in the threat of a "negative wealth effect" from the recent stock-market drop and legitimate questions arise about personal consumption in the period ahead.

All of this creates the potential for more headwinds to domestic economic growth -- not exactly what the stock market needs right now.

What Are the Recent Crash's Ramifications?
I spelled out 20 lessons yesterday that we should all have learned in the last week. 

Well, here's a 21st one: Monday's schmeissing and the breakdown in the market's pricing mechanism could jeopardize what little confidence remains among retail investors.

This is potentially tragic to the supply-and-demand equation for stocks, as reliance on corporate buybacks is a slippery slope.

As I wrote back in April, "peak stock buybacks" could lie ahead. After all, companies face potentially widening credit spreads, lower high-yield and investment-grade debt issuance, pressure on corporate profitability and margins and a need to preserve cash amid bear-market fears.

Unfortunately, individual investors -- many of whom have already vacated the stock market -- will likely further lose confidence in stocks after Monday's flash crash.

Indeed, yesterday could have been the virtual death knell for the retail investor. And importantly, any resulting market weakness could bleed into (and adversely impact) the trajectory of the U.S. consumer's recovery.