Maybe the dumb money isn't so dumb after all.
Individual investors always seem to jump into stock rallies when they should be getting out. But after two crashes in 10 years, the little guy decided to stay on the sidelines this past year — and played the fool again. Stocks just kept going up and up.
Well, at least until this month.
The professionals who have been pushing shares higher for 14 months discovered during the past few weeks something Main Streeters caught on to a while ago: Stocks are dangerous.
"They were always thinking stocks were going to go back down again," Mark Luschini, chief market strategist at Janney Montgomery Scott, says of individual investors. "The scar from investment declines hasn't gone away,"
Though markets rallied Friday, most major stock indexes are down now about 10 percent from their late April peaks. Such reversals, called "corrections," are common during a bull market, and many analysts believe this market was long due for one.
Still, investors — professionals as well as individuals — are unnerved. One measure of market jitters is the VIX, a market indicator commonly referred to as the fear index, which tracks expectations of big swings in stocks. From late April, the index has nearly tripled to levels not seen in over a year.
The change in market sentiment has come fast.
Last month, the question on everyone's lips was whether Corporate America would post earnings that showed the economy was indeed gaining strength. Then the numbers came in, and they were impressive. Instead of just slashing costs to generate profits, companies actually sold more, too.
In other words, that great engine of the growth, the American shopper, was back. The recovery was assured.
Then came fears early this month that Greece's debt troubles could spread, perhaps slowing or even halting growth throughout the world. Stocks began to pull back. On May 6, there was the so-called "flash" crash, sending the Dow Jones industrial average down to a loss of nearly 1,000 points in less than 30 minutes.
Last week served up more unsettling developments: a financial reform bill in Congress that could crimp bank profits, the sinking of the once surging euro and fears that a $1 trillion bailout of Greece might not stop it from defaulting.
On Friday, the Dow closed at 10,193, up 1.3 percent for the day but down 9 percent from its late April peak.
Some market observers say the fact that professional investors have been selling recently is less worrisome than their doing so indiscriminately.
Bill Fleckenstein, a Seattle hedge fund manager, says that in big selloffs, it's individual stocks or sectors that lead markets lower. But now everything seems to fall in unison, suggesting that investors are uneasy about owning any stocks.
"What we've seen in recent days in something different than anything I've seen in 30 years," he says.
Bob Doll, chief investment officer at the money management firm BlackRock Inc., echoes that view.
"I think a lot of people are selling now and asking questions later," he says. Adds Daniel Alpert, managing partner of Westwood Capital LLC, "Now everybody is reconfiguring their portfolios, trying to get defensive."
Not surprisingly, some professional investors think the wholesale selling is overdone.
David Marcus, CEO of Evermore Global Advisors in Summit, N.J., says he's using the market drop to buy a little. "We like to go where there's panic, because in the midst of the crisis you get the best opportunities."
If the past is any guide, individual investors might not join him anytime soon.
Investors pulled $25 billion out of stock mutual funds after the market bottomed last year, according to the Investment Company Institute, a mutual fund industry trade group. Meanwhile, they stuffed bank accounts with cash and loaded up with bonds. Last year saw $376 billion flow into bond funds.
If there's more turmoil in stocks, though, the individuals playing it safe may not escape completely unscathed.
Money manager Richard Bernstein, a former Merrill Lynch strategist, notes that some of the bonds that individuals have loaded up on are junk bonds, dicey ones issued by companies with iffy prospects. If stocks fall, there's a good chance junk will lose money, too.
"They got greedy," says Bernstein of the little guys.
Tobias Levkovich, chief U.S. equity strategist at Citigroup, thinks they'll get greedy for stocks soon, too. He notes that some individual investors had finally started putting money back into stocks before the recent drop, and he thinks they won't be able to resist if the market resumes its climb.
"They tend to chase the market," he says. "If it rallies, they'll come back in."