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  • Eric Hahn

The Market Really Is Different This Time

The market has hit Dow 22000 not because of the individual investors Wall Street calls “the dumb money” but in spite of them.

Over the past month, small investors have pulled $17 billion out of U.S. stock mutual funds and exchange-traded funds and added $29 billion to bond funds. That’s the latest leg of a long-term trend: Since the internet-stock bubble burst in 2000, investors have withdrawn half a trillion dollars from U.S. stock mutual funds.

Instead of chasing this rising market upward, individual investors have been backing away from it. That retreat is increasingly automatic and has become an integral part of how the stock market works.

As millions of Americans reach the age of retirement and have to replace their salaries, they look less to stocks for growth and more to bonds for income. A massive industry has arisen to make that easy.

Financial advisers, many of whom “rebalance” or periodically adjust portfolios to keep them in line with pre-set proportions in stocks and bonds, control more than $5.5 trillion in assets, the Wall Street Journal recently found. And target-date funds, those retirement-saving portfolios that automatically scale back their stockholdings as investors age, held $998 billion in assets as of June 30, according to Morningstar.

Target-date funds made up 20% of assets in 401(k) retirement plans at yearend 2015, up from 18% in 2014 and 15% the year before, reckons a new report from the nonprofit Employee Benefit Research Institute and the Investment Company Institute, a trade group for the mutual-fund and asset-management industry.

“More and more money is being invested according to asset-allocation strategies,” says Brian Reid, the ICI’s chief economist.

The math is simple: If you had a target of 50% in stocks and they go up 10%, you are suddenly off-target, with more than half your money there. Your financial adviser or target-date fund will automatically sell stock and buy bonds to get you back to 50%.

That’s what happens now, mechanically, millions of times a month as the stock market rises. Such continuous, gradual selling may well have helped the market rise so smoothly and keep it (so far) from overheating.

Even investors who aren’t automatically rebalancing are thinking as if they need to, says William Koehler, president of FCI Advisors, an investment firm in Overland Park, Kans., that manages $7.6 billion primarily for individual clients.

As Mr. Koehler puts it, the most common question his firm heard from clients back in 1999 was “Should I just buy Cisco?” (Cisco Systems was then one of the hottest technology stocks.) Now, he says, it is: “Do we have the right mix of stocks and bonds and cash?”

Welcome to the homeostatic market. In biology, homeostasis is the process by which living organisms regulate vital aspects of their internal environment, keeping such factors as body temperature or chemical balances close to their “set points” or target values.

These automatic adjustments don’t mean stocks can’t crash or soar from here. But such sharp moves are at least somewhat less likely, and less likely to last, in a homeostatic market.

So don’t believe anyone who tells you Dow 22000 is driven by euphoric “dumb money.” This is a market in which millions of small investors have been selling, not buying.

Portfolio &
Money Management


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