When Stocks Sink Many Investors Manage to Profit
“Buy on Weakness” has become the guiding philosophy of a huge group of individual investors since 1987. Whenever stocks take a sharp hit, these folks happily jump in.
Thus far, the B-O-W crowd has been right every time, collectively speaking. Chances are you’ve made money if you bought after the 1987 market crash, or if you bought as prices fell in the brief but ugly bear market in the fall of 1990; ditto for the Soviet coup attempt last August, when the Dow Jones average lost 100 points to 2,898, and for the mini-crash last Nov. 15, when the Dow dropped 120 points to 2,943.
So it’s not terribly surprising that many individual investors rushed into stocks on Tuesday and Wednesday, as institutional share owners bailed out on worries over the Tokyo stock market’s meltdown.
And once again, the individuals look amazingly smart: After a 94-point plunge on Tuesday and Wednesday, the Dow leaped 43.61 points to 3,224.96 on Thursday, as the Federal Reserve surprised everyone by easing interest rates.
How do we know what the small investor was doing this week? Mutual funds and discount brokerages provide a good gauge. At the Financial Funds mutual fund group in Denver, for example, the ratio of buyers to sellers in the firm’s stock funds was a stunning 95 to 5 on Wednesday.
The Vanguard Group of mutual funds in Valley Forge, Pa., also reported net inflows into its stock funds on Tuesday and Wednesday, as the market slumped. And discount brokerage Charles Schwab & Co. in San Francisco said stock purchases by individuals totaled $100 million on both Wednesday and Thursday, while sales totaled $90 million each day.
Skeptics might say that individuals have just been lucky so far, and that buying on weakness has become too automatic, too easy. At some point, the market is going to teach the B-O-W gang a painful lesson, some Wall Streeters argue: The small investor will continue to buy on each swift market plunge, but each succeeding rally will be weaker than the preceding one. By the time the B-O-W investors understand what has happened, they will be deep into a multi-year bear market, and they’ll have racked up stunning losses.
What the bears are describing there is basically the Japanese stock market since 1989--which, even after two years of decline, continues to fall like an anvil.
Well, maybe the bears will be right eventually. But the assumption they’re making is that every time someone in the B-O-W crowd buys a stock, they’re buying to keep it forever. In fact, the evidence suggests something different. It appears that many individuals have learned how to ride the short-term waves caused by the market’s whales--the institutional investors.
Why should it be easy for individuals to trade around the institutions? Consider the way many billion-dollar institutions invest. They use computers to suddenly dump massive amounts of stock at the first sign of trouble. Money management, after all, is a performance game--no big investor wants to take the chance of being the last one out the door.
Meanwhile, the institutional machine works just as badly in reverse. When the market begins to take off, institutions (or their computers) often throw every last dollar available at stocks, in a desperate attempt to boost portfolio returns.
That kind of trading often produces huge one- or two-day moves in stocks, and it often pulls many issues way up, or way down, even though there’s no change in the companies’ fundamentals.
Now consider the nimble small investor who does his or her homework on individual stocks. Figures from Schwab & Co. suggest that many individuals knew exactly how to enter and exit the market this winter and spring, as the institutions herded in and herded out, fueling major rallies and slumps in their wake.
In January, for example, Schwab says its customers sold $3.6 billion worth of shares while buying $3 billion. So the majority were selling into the tremendous rally that ran from mid-December to late-January. Then in March, as many stocks fell sharply because of institutions’ growing nervousness, buyers topped sellers at Schwab $2.4 billion to $1.9 billion.
Schwab is just one discount broker, of course (albeit the largest). Certainly, many individuals have played the market just as wrong this year as many institutions. But what the numbers strongly suggest is that quite a few small investors have become very adept at buying their favorite issues when they drop sharply, and selling them when they skyrocket, thanks to the skittish and heavy-handed institutions.
Funny, but that sounds a lot like “Buy Low, Sell High”--which is exactly the way you’re supposed to do it in the stock market.
Paradise for Traders
How some stocks plunged Tuesday and Wednesday, then rebounded Thursday.
Price change: Thurs. Thurs. Stock Tues./Wed. Thurs. close gain Tokos Medical -2 7/8 +3 3/4 28 1/4 +15.3% Outboard Marine -2 1/4 +1 3/8 20 1/2 +7.2% Schwab Corp. -2 +2 30 7/8 +6.9% J.P. Morgan -3 7/8 +3 3/8 55 7/8 +6.4% Staples Inc. -3 1/2 +1 5/8 29 3/8 +5.9% Georgia-Pacific -4 +3 1/8 63 3/4 +5.2% BankAmerica -2 1/2 +2 40 7/8 +5.1% AMR Corp. -2 3/4 +3 1/8 71 7/8 +4.6% Caesars World -2 5/8 +1 1/4 38 +3.4% GE -2 3/4 +1 7/8 74 3/4 +2.6%
All stocks trade on NYSE except Tokos and Staples (NASDAQ).
