Dallas, TX
July 12, 2010, 08:00 EST		 Dr. Joe Duarte's Market I.Q.


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Small Investors Abandon Stock Market
What's Hot Today:

U.S. stock index futures were flat on Monday. Wall Street's recent bounce is due for a pause, especially as earnings season begins.

Today's Economic Calendar



News For Thought

Union begins aggressive campaign for fall elections. According to The Washington Post: "The AFL-CIO is launching the first stage of its field operation for November's elections, dropping more than 300,000 flyers at worksites in 23 states over the next two weeks. States included in the blitz are "Colorado, Connecticut, Delaware, Florida, Iowa, Indiana, Kentucky, Maryland, Michigan, Minnesota, Missouri, New Hampshire, New York, North Carolina, Ohio, Oregon, Pennsylvania, Texas, Washington and Wisconsin."

Governors are concerned about Federal court proceedings against Arizona immigration law. According to The New York Times: "Democratic governors expressed concern that the Obama administration’s suit against Arizona’s new immigration law could cost a vulnerable Democratic Party in the fall elections."

Local and state government woes next worry for Federal Reserve. According to Reuters: "Next year's state and local government budget gap is expected to reach $140 billion, or a little more than 1 percent of gross domestic product. Considering economists expect GDP growth of only about 3 percent next year, that is a substantial hit. In the first quarter of 2010, the most recent period for which full data is available, state and local governments subtracted 0.5 percentage point from gross domestic product. That was equal to the reduction from commercial real estate, a primary area of concern for the Fed." The Fed has had little comment on the subject, but some economists are saying that the situation is likely to hit the central bank's focus as time passes.

Small Investors Abandon Stock Market
Does The Absence Of The Small Investor Signal The Buying Opportunity Of A Generation?
Small investors are abandoning the stock market leaving professionals and computers in charge. Is that a bullish or bearish sign ultimately?

The contrarian view of investing is that when you bet against the small investor, in times of extreme joy or fear, you'll make money. The theory is that the little guy always gets it wrong at market extremes, buying into rallies near the top and selling at the bottom. That's why the current situation, in which small investors are clearly capitulating is worth exploring.

According to The Wall Street Journal: "Many individual investors were tiptoeing back into stocks in the spring. Now, they're running for cover again." Frightened by the Flash Crash and the rising volatility due to computer model based trading, small investors are getting fed up with stocks and moving their money into bonds, annuities, and even cash. The Journal reported: "Small investors' faith in stocks, which surged in the 1990s, has collapsed since the technology-stock debacle and the Enron and WorldCom scandals of 2000-2002. The 2007-2009 financial crisis only made things worse. Now, the pullback among ordinary investors means they are a declining force in a market that is increasingly dominated by professionals."

This isn't the first time this has happened. According to the Journal: "in 2002, investors withdrew more money from mutual funds that invest in U.S. stocks than they put in. Then from 2007 through 2009 they withdrew money for three consecutive years. That marked the first three-year period of withdrawals since 1979-1981, according to the Investment Company Institute, a mutual-fund trade group. This year, U.S.-stock funds saw inflows in January, March and April, but net withdrawals resumed in May." Yet, contrary to the traditional contrarian view, the periods during which small investors withdrew money from mutual funds corresponded to periods when the markets declined significantly.

In fact, the Journal reported: "Individual investors were important market pillars in the 1990s, but their flight from stocks is changing the market dynamic. By adding money to mutual funds, individuals helped push stocks higher in the 1990s and to a lesser extent from 2003 through 2006. Now they are moving money out again on balance, making them a drag on the market."

And what's most interesting is that individual investor money flows may be a whole lot more significant than the contrarian investment theory accounts for. According to The Journal: "After getting hurt in the 2000 tech-stock crunch, individuals came back to U.S.-stock funds in 2003, as stocks were entering a new bull market, ICI data show. But the buying proved tepid and turned to net selling in the latter part of 2006, even before the bull market ended in 2007. Despite occasional periods of inflows to U.S.-stock funds, the selling trend has continued since then. Individuals removed a net $7 billion from stock funds in the seven days ending May 12 and $13 billion two weeks later, eclipsing the deposits from earlier in the year."

That suggests that when small investors move en masse, they have the ability to affect the markets, via the activity in mutual funds. And that makes sense, mutual funds are little more than money sieves in and out of the market. As long as money keeps pouring in, they buy stock. And when they are hit with withdrawals, the effect is the opposite.

And if you look at what stocks have provided, you wonder why it took individual investors, who are mostly buy and hold investors, so long. According to The Journal: "The Standard & Poor's 500 stock index has fallen at an annualized rate of 3% a year over the past 10 years, including dividends and controlling for inflation. Long-term Treasury bonds show a gain of 5% a year during that same period, after inflation. Gold is up 10% a year and real-estate investment trusts 8% a year. The S&P 500 index itself, without adjusting for inflation and dividends, is stuck today at a level it first reached 12 years ago, meaning it has gone nowhere in more than a decade, scaring a legion of people in the process."

So it's no surprise that rallies don't last as they once did, or that market breadth has been weak of late. Most interesting is this: "individual investors appear to be losing faith in an investment strategy called buying on the dips. In times of stock strength, people learn to buy stocks after a decline, when they are cheaper, because the stocks have a tendency to recover. Lately, investors have been reversing that behavior, selling on dips for fear the declines will continue. The Yale School of Management maintains an index, designed by Professor Robert Shiller, that tracks individuals' willingness to buy on dips, based on a monthly survey of wealthy investors. The index topped out in 2002. While it has moved up and down since then, it has been falling since the start of 2009."

Perhaps, this is the most telling of all facts. According to The Journal: "Some investors, haunted by the continuing credit crunch and unemployment fears, are being driven to pull money out of stock funds to make up budget shortfalls. Also eating away at risk tolerance is demographics: Baby boomers are aging, making them think more about preserving their holdings' value. This is only part of the story, however: The Investment Company Institute data show lower risk tolerance among younger people, too. In surveys of mutual-fund owners, the ICI found that just 30% said in 2009 that they were willing to take above-average or substantial risk in the stock market, down from 37% in 2008. The number willing to take only below-average risk or no risk at all rose to 20% from 14%."

Conclusion

American investors are returning to behavior patterns not seen for three decades. And if investing behavior is an indication of overall behavior, things will be different for a good while, given the penetration of the behavior accross all age groups and demographics.

What makes the data in this article compelling is the connection between individual investor mutual fund withdrawals and the persistence of long term down trends in the stock market over the last decade.

That suggests that the current down trend, may not end for some time.

And here's where things may be most telling. Conservative behavior is life may translate into conservative tendencies at the polls. So just when the "change" dynamic is trying to deliver its coup de gras, it may run into a new wave of conservatism.

We are clearly in a state of flux in this market, and in the country.

We'll be on Twitter some time today before the market closes with some updated comments.

Know when to sell and how to make money when the market falls. Get a detailed trading plan in your pocket. Read Dr. Duarte's All NEW Books "Market Timing For Dummies." and "Trading Futures For Dummies." The Trading Manuals for All Seasons. Also Available As Kindle Books.

 

Market Moves - Stock Of The Day
Starwood Hotels (NYSE: HOT) Holds Above Long Term Support
Shares of Starwood Hotels (NYSE: HOT) seem to be gathering support.



Chart Courtesy of StockCharts.com


The hotel industry traditionally suffers from economic softness. Yet, over the last few months, during our frequent travels, we've noticed that hotels don't seem to be hurting.

This scribe stays mostly at Hilton brands. And Hilton is a privately held company, with a large debt load. Yet, despite reports of some difficulties, Hilton's middle market brands, Hampton Inn, and the slightly higher level Homewood Suites, in smaller and middle sized markets are consistently full during weekends, as far as we've seen.

This past weekend, in San Antonio, we saw more of the same, full parking lots, and heavy traffic. But not just at Hilton Brands. Other imprints had the same activity, including Marriott, Omni, Hyatt, and Starwood.

And if traffic is what moves hotels, the Starwood shares may be telling us something. The stock bounced off of its 200-day moving average recently, and is showing signs of continued improvement in this market, which is also trying to bounce.

Starwood's earnings are due to be released on July 22nd, before the market opens. Shares seem to be moving up ahead of the announcement, suggesting that others besides us have been looking at traffic in the hotel industry.

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