Overcoming the Herd’s Instincts

Ian Cassel Blog, Market Analysis Leave a Comment

I found this article By Josh Levine very interesting as it relates to micro-small cap performance going against the grain of fund redemptions.

The Russell 2000 Index is up a healthy 30% since October. The small-cap benchmark remains within striking range of its April 2010 high even after its pullback during the past two weeks. Despite the upbeat trend, the action has done little to ignite the animal spirits of investors. In fact, a nearly year-long string of net redemptions for small cap funds continues to occur.

Retail investors have pulled more than $18 billion out of small-cap funds over 37 of the 40 weeks through February, even as the Russell 2000 has climbed significantly higher over the past 20 weeks. The charts below illustrate how the herd’s instincts were proven wrong once again.

The sad reality is individual investors make this mistake repeatedly — selling when they should be buying (and buying when they should be selling).

“In other words, buying of small-cap stocks so far remains restrained,” according to the Journal article. “If the Russell 2000 can push through to record highs, that alone might trigger a wave of new investor interest. Hedge funds, in particular, are likely to move into more volatile investments like small caps if there is a sense that the market is climbing without them.”

Small-cap stocks often lead during the early stages of a rally, and the current price gains might be the start of a long bull cycle for emerging growth stocks. It’s too early to tell for sure.

Whether the flow of individual investor money into small stocks picks up soon is also difficult to figure. Though confidence about the economy is building, investors remain fearful and show little inclination to jump back into the action with both feet. As history shows, however, investors will eventually find their way back into the markets at much higher valuations.


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