LPL's Kleintop: Market Structure Fears Behind 'Buyers Strike'

Inherent problems in the stock market have investors rattled

U.S. stocks are up 15% in the last three and a half months, according to Jeffrey Kleintop, chief market strategist at LPL Financial, but individual investors are doing more selling than buying. In an Oct. 18 commentary on the state of the market he said investors are on a "buyers strike." Kleintop cites Investment Company Institute data that show in the last 25 years there has never been a three-month gain in the S&P 500 of 10% or more that wasn't accompanied by inflows into equity funds or ETFs.

It's not stocks that investors are afraid of, though. Kleintop writes that investors haven't abandoned foreign stocks or U.S. bonds, including emerging market stocks and high-yield bonds. He theorizes that the distrust may be of the market itself.

"While individuals may have overcome to some degree their distrust of the durability of the economic recovery and policymakers in Washington, they remain distrustful of the integrity of the U.S. stock market," he writes, citing the flash crash of early May, which has led to a loss of $53 billion from domestic equity mutual funds, as an example. That crash was triggered when a mutual fund company used an automated computer sell program with "no regard for price or timing" to sell S&P 500 futures.

The Securities and Exchange Commission admitted that under "stressed market conditions," extreme price movements like those seen in the flash crash could happen again.

Part of the problem, according to Kleintop, is that most volume trades take place electronically, off the NYSE and NASDAQ. That, along with millisecond trading, unbalanced transparency, and electronic trading strategies that "damage market integrity through the almost instantaneous creation and cancellation of millions of orders," has strained the stock market.

"It would be unfortunate if this record-breaking buyers strike by individual investors is a precursor to a permanent boycott by individuals from investing in U.S. stocks," Kleintop laments. He acknowledged that the intra-day breakdowns in liquidity are challenges to investors, but said they've had "little to no effect on investing through mutual funds and ETFs for a time horizon that exceeds a single day." Furthermore, future gains will be hard to come by if individual investors don't return to the stock market.

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