One of the first lessons anyone learns about investing in stock market paper is that not all investors are created equal. The big players on Wall Street, collectively referred to as institutional investors, get a better deal than the rest of us. They get a better buy-in price, better terms and, when the market starts to dip, computerized trading systems make sure they’re out of the market before losses add up. The people who really take a beating in down markets are 401(k) investors, who sometimes have limited ability to trade.
Despite the inherent unfairness of the system, it’s not all bad for those of us on the lower end of the economic scale because some of those institutional investors are pension funds and life insurance pools. Most people would agree that it’s probably okay for them to get a good deal when protecting the money that supports retirees.
In many ways these large institutional investors, which manage amounts of money measured in trillions, are the stock market. Fund managers and big institutions are the first ones in on rallies and the first ones out during a crash. That’s why the actions fund managers are taking now may be our best insight into the current health of markets.
Moving to Cash
It turns out big investors are fairly downbeat on the stock market and that institutional gloom is now spreading out through all of 2016. In fact institutional investors have been quietly moving away from paper assets since 2014 and now hold more cash than at any time since 2004. Rising cash levels are a clear signal that even the big players don’t trust the market right now. Unfortunately, it also tends to become a self-reinforcing downward spiral as this sell-off of stocks and bonds necessitates even more selling as fund managers need money to pay their investors who want to cash out.
Increased Volatility Ahead
Institutional investors tend to be conservative and cautious, not bad qualities in those managing teacher and firefighter pensions or the mutual funds you’re counting on for retirement. When those cautious and conservative investors, sometimes called the “long money” in investment circles, move to the sidelines that gives hedge funds, high-speed traders and Exchange Traded Funds, which tend to trade more often, greater sway in the market. More trading means greater volatility and that’s exactly what we’re seeing now. The long money investors won’t come back to the market until the big price swings settle down.
Good for Municipal Bonds
There are some winners when equity markets start to become irrational, specifically municipal bonds. That’s good news for cities and states that need to make infrastructure upgrades. With the Federal Reserve likely to continue raising interest rates the future of municipal bonds looks bright through the rest of this year at least – good news if your town needs school and road repairs.
Great for Gold
Another winner in the flight to cash by big investors is gold. Prices for gold have risen three percent since the beginning of the year as investors kick themselves for not rebalancing their portfolios while the stock market was churning upwards. Maybe the lesson about paper investments will actually stick this time but don’t count on it.
Stay Out of the Kill Box
One of the traditional defensive sectors in volatile markets is energy, but not this time around. With oil prices likely to stay depressed, energy stocks are getting killed and those who jumped back in thinking we found a bottom in oil stocks got hammered. It’s going to be a long time before institutional investors trust energy stocks again.
This market is a good reminder that stock market investments are nothing but a paper promise with very little substance. Smart investors are going to play it safe going forward in 2016.
Will Granderson is a regular columnist for Goldco Precious Metals writing on finance, precious metals, and gold as an investment and in popular culture.