Wall Street ‘Tude’ is More than Just Rude

Wall Street has coined the name for retail investors: ‘dumb money‘. And, as headlines like “Investors resist the siren call of equities” suggest, Wall Street is now surprised that retail investors are fleeing the market in droves? Who’s dumb?

Retail investors have lost confidence. They feel manipulated by brokers and betrayed by the market. Clearly the government hopes that more regulation will help. It won’t.

Regulation doesn’t build confidence; regulation prevents confidence from slipping away. It’s a bit late for that! What builds investor confidence is success. Success cements an “I can do it!” attitude.

What pari-mutuel betting means for investor confidence


Parimutuel betting is based on confidence in one’s own opinion. Investing isn’t like games of chance. There are no fixed “odds” in investing. Investing is a game of outwitting your foes. So what happens when people keep losing at the track? The obvious happens. It’s no longer fun to bet. So they stop betting.

Those retail investors who are still betting on the “race” are jettisoning their old ways of thinking. For example, right now, the P/E (price/earnings) ratio is being dumped in favor of reports about the US and global economy. They’re even latching onto new indicators like the ‘Hindenburg’ omen.

What the Hindenburg omen indicates

The Hindenburg omen is a technical indicator of when to get out of the market. It has a 25% success rate. That means the market has declined only one out of four times when the Hindenburg predicted it would go down. The Hindenburg omen indicates retail investors are desperate for new measures of the market.

What market indicators measure

The problem with any measure or “indicator” of the trend of the market (or of a company or industry) is that retail investors have reified (i.e., concretized) indicators into facts in and of themselves. Investment indicators mean nothing in and of themselves.

Understanding that investing is a parimutuel betting game means realizing that indicators of the market, to be useful, must actually measure investor sentiment. It’s investor sentiment, and not “chance” as in probability theory, that shapes the odds for the whole market or for any given part of the market.

To be useful, there has to be an explanation of sorts underlying why indicators should work. Otherwise, when their indicators fail, novice investors, like ancient tribes who worshiped deities, run from the old ones to the new ones.

For example, knowing all the factors of a horse race (the horse, its parentage, its trainer, its jockey, the condition of the track, the weather, and the horse’s competitors is like knowing the fundamentals of investing. Those who know companies, industry sectors and markets have a “reality check” to alert them whether market indicators are likely to be accurate or not.

Right now experts are skeptical of the low p/e rates. And rightly so. A Wall Street analyst quoted in the Wall Sreet Journal article, “The Decline of the P/E Ratio” says, “The market is worrying not just about a slowdown, but worse. People want clarity before they  make a decision with their money.

The article’s authors assert “The P/E ratio tends to fall as uncertainty rises and vice versa.” They underscore  this opinion by pointing out the fall of P/E ratios during the Depression in the 1930s, after WW II, during the 1970’s, and in 1980.

About a week before the above WSJ article, the Financial Times warned about dangers of trusting any “spurious accuracy” of p/e ratios. In particular they point to one type of p/e that  “awards undeserved authority and accuracy to something that is an educated guess.” In its brief item, “P/e multiples,” the FT advises “Treat a p/e as shorthand for what the market might be thinking; not a short cut to serious investment decisions.”

The problem with the FT’s opinion is that in the end investing is just “an educated guess.” Because of this, there is a danger that investors seeking to use global economic indicators to measure the markets will create a self-fulfilling prophesy of doom from bad news.

What retail investors need now

What retail investors really need are (1) solid market indicators that will build their confidence, and (2) regulation that prevent confidence from being lost due to the machinations of Wall Street brokers, traders, and con men like Madoff.

Can solid indicators of the market(s) be found? I wouldn’t know, but I suggest experts on Wall Street and the universities start digging for some good market indicators soon, and that regulators begin leveling the playing field.

If not, I can’t imagine how Wall Street will get retail investors to bring their “dumb money” back into the market. Not after we’ve all become wise to what Wall Street has been doing with other peoples’ money.

Copyright © 2010 Nancy K. Humphreys

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