In our last post, we made the point that small investors are having a smaller impact on the stock market.
So what does it all mean?
For one thing, it signals a significant change in the role of the small investor. In the 1990s, as small investors jumped into the market in force, they increased demand and pushed stock prices up. Now, as investors flee the market, their exit is becoming self-fulfilling to some degree, as the exit by a large number of investors has held down stock prices.
The market void is being filled to some degree by high-frequency trading (HFT), in which computer-driven trading by large firms attempts to take advantage of momentary pricing inefficiencies. With HFT, highly leveraged trades take place in nanoseconds.
Readers of Wenning Advice, our electronic newsletter, may recall our last issue, in which we discussed the increasing dominance of HFT and its role in the “flash crash.” We noted that HFT now accounts for a majority of equity trades. TABB Group, which researches financial markets, found that HFT accounts for 73% of all equity trading, up from 30% four years ago.
With small investors leaving the market, the dominance of HFT will increase.
The down side is that as investors leave the market, pricing is less reflective of demand. Pricing historically has been driven by the principle of supply and demand. A stock performs well when its fundamentals demonstrate great potential for investors.
Early predictions are that profit reports will be very favorable this quarter. As companies post their quarterly profits, it will be interesting to see how the market reacts.
It’s difficult to tell just how the market will react. HFT could, in fact, contribute to wider price swings than if prices were affected solely by investor sentiment. As such, short-term, we believe it is wise to keep stock investments in place, as investors who sell now could miss out on a major opportunity.
Long-term, though, many factors are working against the market, including the potential of a double-dip recession and the possibility of continuing sovereign debt issues in Europe.
What about in years to come? We believe that the role of the small investor, like the market itself, will ebb and flow. The small investor will be back and the market will benefit as a result.