After nearly a generation of selling common stocks on balance, individual investors are returning to the stock market. They are investing cautiously and with a better sense of value than the institutional investors who dominate the market today. If individuals continue their return to equities, it could be the beginning of a new kind of stock market.
Individual investors began to sell more stocks than they bought in 1958. By 1962, their selling was large enough to offset their purchases of mutual funds, and they have been net sellers every year since.
Individuals have been very good judges of value in their sales. Since the Dow Jones industrial average is no higher today than it was 15 years ago, investors who sold stocks then avoid more than a decade of disappointment. Individuals sold stocks heavily during years when the stock market was high, but sold only lightly when the market was law. They sold $6.5 billion of stock and mutual funds during the bull market year of 1968, but only $1.2 billion during the bear market of 1974.
If individuals were shrewd to sell stocks, then someone had to be naive to buy them. The naive buyers were the institutional investors who manage the nations' pension funds, bank trust departments and mutual funds. Pension funds in particular have been heavy net buyers during the last decade when stocks have been painfully poor investments.
According to conventional wisdom, professional investors have the education, experience and research capability to outperform naive individual investors. In practice, individuals in aggregate have done a much better job of investing than their professional counterparts. When the Dow hit its low for this market cycle in the first quarter of 1978, pension funds became net sellers of stocks for the first time ever in a remarkable example of selling low the same stocks they earlier bought at higher prices. By contrast, individuals changed from net sellers to net buyers during that same bargain period. Individuals were net buyers again in the first quarter of 1979 and probably in the second quarter as well.
It is too soon to be certain that individuals have started a large and continuing trend back into stocks, but if they have, the reasons are fairly clear and the consequences are potentially major.
One cause for the return of individuals is that they seem to be very sensitive to value, much more so than their institutional counterparts. During the last 15 years that stock prices have been flat, the earnings, dividends and assets that those stocks represent have grown substantially. The stocks that make up the Dow industrial average sell at only 7 times earnings today rather than at 17 times earnings as they did in the mid 1960s. This creates the value that makes stocks more attractive now.
Many of the individual investors who avoided stocks put their money into real estate, gold, diamonds, commodities and collectibles which have appreciated substantially. The contrast between stocks, which have been flat, and other assets, which have risen sharply, makes stocks look relatively more attractive on a value basis.
Congress also helped to make stocks more attractive to individuals. The maximum tax on long-term gains recently fell from 49 percent to 28 percent, thus giving a substantial incentive to the nation's shareholders.
The recent experience of individuals in stocks has been favorable. While the large stocks that institutions concentrate in have appreciated only moderately since the market low in 1974, the smaller stocks that individuals concentrate in have done much better.
Whatever the causes that motivate individuals to invest in stocks, the consequences could be both major and beneficial to the economy.
One immediate consequence of the return of individual investors is the current renaissance of venture capital activty. The major social justification for the stock market is not the provision of a nationwide casino for investors' entertainment, but rather the provision of capital for promising enterprises. Congress cut the capital gains tax in the hope that it would stimulate venture capital, and recent events have justified that hope.
Venture capital is the natural province of the individual investor, not the institutional one. Institutional investors tend to be cautious and averse to risk, particularly where speculative investments could put their own jobs at risk as well as their clients' capital. Individuals tend to be more willing to depart from relatively safe investments to take an occasional chance that today's new venture may be tomorrow's IBM.
Another consequence of the return of individual investors could be a substantial bull market in stocks. Despite all the assets they control, institutional investors are unlikely to be leaders of any sharp upside move in stocks. The last decade of reporting poor results to clients has left institutional investors profoundly discouraged and skeptical. Institutional investors probably would follow any bull market in stocks, but they aren't venturesome enough to lead it. If individuals continue their trend back into stocks, they could provide the venturesome leadership for the kind of bull market that has all but faded from the memory of most institutional investors.
Even if the return of individual investors doesn't result in higher stock prices, the broadening of share ownership is desirable on a social basis. The decline in U.S. shareholders from 30.8 million in 1970 to 25.3 million in 1975 resulted in a greater concentration of corporate ownership. The return of the individual investors that seems to be taking place now suggests greater public concern and participation in the future of private enterprise capitalism.