You’re Optimistic; The Pros Aren’t. Don’t Let That Stop You.

They’re certainly a gloomy lot, those professional investors. More than two-thirds of fund managers surveyed recently said the market’s strong performance since October has been nothing more than a bear market rally. And so they’ve sold their stocks and are up to their eyeballs in cash. But, that doesn’t mean you have to follow suit. The fact is, you might know better than the pros.

What’s going on here?

The latest Bank of America fund manager survey showed that the composite index of optimism versus pessimism (blue line) is hovering near 20-year lows.

The composite index of optimism (blue line) from the latest Bank of America fund managers’ survey. The index measures respondents’ economic growth expectations, along with how much of their funds they’re devoting to stocks and cash. Source: Bank of America.

But “why so nervous?” is the loud chorus from the retail investor world. See, they’ve been pouring money into the stock market in record amounts this year, proving that when they burst onto the scene in 2020, they were just getting started.

The chart below shows retail daily inflows into US shares (red line) and the price of the S&P 500 (green line).

Retail investors’ daily inflows into US stocks, green line, in millions of dollars, left axis. The price of the S&P 500, red line, right axis. Source: VandaTrack.

So, who’s in the know?

Professional investors can be quick to dismiss retail investors as “dumb money”, given their past tendency to pile into stock markets near peaks and panic-sell at troughs. Mind you, this condescending claim does have some merit – on the chart, those two lines do move somewhat synchronously, and high levels of retail inflows have been a warning sign for markets in the past.

Now, if these record retail inflows had been occurring at market highs (like the last market top in January 2022), then I might be willing to say that could be concerning. But, they’re not. In fact, the market – while nicely off its lows – is still meaningfully below its January 2022 high. And because of the blustery economic crosswinds right now, it’s frankly anyone’s guess which way stocks will go. That means record-high retail investor inflows can’t be automatically dismissed as just some suckers buying shares near the top of the market.

What’s more, there are plenty of things on the longer-term horizon (like the growth of artificial intelligence) that could mean a bright future for the market. So taking a step back, maybe it’s retail investors (in particular those with long enough time horizons) that should be dismissing the professionals – and their gloomy outlooks – this time around.

Why are the pros so glum?

Near and longer-term market setup aside, there are three other, less spoken-about reasons why the professional investing world’s wired to be cautious. And it’s worth retail investors bearing these reasons in mind. See, being overly negative can be a losing mindset, given that stocks rally more often than they fall. And this partly explains why professional investors, on average, perform no better than retail investors over time. Here are those three reasons:

1. It’s plain-old career survival.

Pro investors understand that a cautious investment approach might mean they underperform in a rising market. But this is something they can generally live with, because they can explain it to their clients with a sugarcoated message like: “I’m sensible and won’t invest your money in overly risky stocks that are too expensive”. And their clients usually swallow this narrative. After all, if the market is up, say 10%, and their manager has returned 8%, they’ve still made money. But, this is not the case when markets fall. Falling markets mean clients lose money, and that makes them grumpy. And just like sports team owners with a losing head coach, clients can be quick to fire their fund managers. Given the choice, then, pro investors often prefer to adopt an approach that sets them up to outperform a falling market (protecting their jobs) while accepting this might mean they lag a rising market.

2. It’s just business.

Somewhat linked to the above, client pitches are usually designed to showcase a manager’s focus on risks. That generally means giving the impression that the manager is acutely tuned into what could go wrong. This style of client pitch can be more successful than the opposite: say, running in dressed in a rocket emoji and proclaiming everything is moon-bound. Sure, I’m exaggerating for effect, but the point is: clients want to know that their money manager is a safe pair of hands and won’t take undue risk with their cash.

On top of this, clients tend to withdraw their money from the market after suffering heavy losses. But they are less likely to pull cash from a fund that’s outperformed a market decline.

3. It just… sounds smarter.

The third reason is quirky, but no less important. Being bearish just sounds smarter. It’s much easier to construct a clever-sounding argument as to why the world is going to hell in a handbasket than it is to tell everyone that things will be fine. Take a look at all the narratives that surround you right now and try to pick out a really smart positive one. The most cerebral-sounding arguments tend to be the gloomy ones.

What’s the opportunity, then?

The obvious conclusion is to ignore the prevailing professional investor sentiment. The reality is that when it comes to predicting market direction, they don’t know any more than anyone else. In fact, their current cautious approach might be a good thing: it means there’s more cash on the sidelines to be invested at some point. And if anything, this resoundingly bearish professional investor sentiment can actually be used as a contrarian indicator – meaning, you might do well to take the opposite approach. This was precisely Bank of America’s takeaway from its last survey: that negative investor sentiment is a good thing for risk assets like stocks.

So, don’t be tempted by bearish pros to pull out of the market in hopes of buying your stocks back at a lower price. Remember, time in the market is better than timing the market.

But, if the risk of buying stocks ahead of a market pullback keeps you awake at night, consider using dollar-cost averaging as your bedtime soother. By investing set amounts at set intervals (every two weeks, say, or every month), you’ll probably end up buying stocks at high, medium, and low prices as the market gyrates. That way you’re limiting your timing risk, while staying invested.