Assessing The Trend Toward More Individual Investors in Capital Markets

The trend toward individual investors in capital markets has been an increase both in the United States and Internationally. However, this trend is also skewed to more conservative investing such as in Government Bonds. This is due in part to perceived market risk and a believe that stock investing is best left to professionals. There are exceptions to this rule, for example in countries with higher than average Gross Domestic Product, riskier investment strategies may include a higher percentage of individuals and/or households.

This article will assess the trend toward more individual investors in the market in terms of national and international investment developments, and reasons for increases in the amount of market investors. Moreover, it will become evident from the information presented herein, that the movement toward individual investing is also tempered by guarded personal asset allocations. Section I discusses individual investment patterns, and underlying investor attitudes as they pertain to their investments in capital markets. Section II outlines some of the catalysts for an increase in individual investment.

Individual investment patterns

The number of U.S. consumers invested in the securities markets either directly or indirectly through retirement plans has risen more than 40% since the 1980's according to realclearpolitics.com, However, at the same time, U.S. and International household savings has declined according to an economic report by Dr. Catherine Mann of The Institute for International Economics. In Germany, a trend toward more cautious investing has emerged since 1997 as evident in a 2008 Celent report on German retail investment patterns; and Chinese household investing has been shown to have skyrocketed tremendously according to a May, 2007 New York Times article by Keith Bradsher.

To illustrate further, trading volume of the Dow Jones Industrial Average has risen from approximately half a billion shares day to a peak volume over nine billion shares. From 1928-1995, trading volume of the Dow Jones Industrial Average stayed under half a billion. The negative market psychology of the 208-2009 recession hasn't seemed to have impacted the trading volume of the DOW either. That is to say, despite a drop closer to 5 billion shares per day in the summer of 2009, average trading volume has actually increased during the recession. Post recession trading volume may be an indicator of the trend of individual investors in the securities marketplace, however accounting for the source of such volume is the real question.

Reasons for this increase in volume include 1) securities market accessibility by individual investors, 2) the expansion of brokerage firm services and 3) an increase in institutional investing. Based on the studies cited in this article, this increase in volume may only represent a minority, but perhaps wealthier portion of the private investment market. Either way, after the internet and real estate bubble bursts, this investment strategy may not suite the average American. This is reiterated by a 2005 USA Today report.

Reasons for increases in individual investment

1. Individual investment technology and information

Investment technology puts investment analysis tools and mechanisms previously only available to brokers in the hands of individuals. With high-speed computing and information transfer, investors are able to access a lot of the information needed for independent investing. Essentially, the technological entry barrier to individual investment has been largely removed from securities investment. Online trading, improved public access to financial information, and reduced brokerage fees and/or commissions are all factors that make individual investing more feasible.

2. Investment brokerage services

Brokerage services have expanded to include the type of financial services individual investors might value for convenience and affordability. This is due in part to the banking deregulation that took place during the 1990's. Specifically, the Gramm-Leach-Bliley Act of 1999 allowed banks to expand their financial services to facilitate modern day banking needs. This in turn gave individual investors more investment service options. For example, discount brokerage firms emerged to provide money market accounts, checking accounts, research and investment tools, online banking and in some cases credit accounts to a greater amount of investors.

3. Market psychology

A look at market psychology reveals a pattern of human behavior that trends toward individual investing yet significant financial caution. First, an example of a growing movement toward individual investing is evident in Australia according to the August 2004 issue of the Journal of Economic Psychology. In this example, Government policy has been indicated to be an promotional influence on individual investment for retirement planning. Thus, in the case of Australia, high individual investment is due in part to Government policy or leadership.

In the case of China mentioned in section I of this article, a massive increase in individual brokerage accounts was recorded in 2007. The psychology behind this is awareness of opportunity and the willingness to take part. Thus, the Chinese example illustrates a pro-active market psychology. Whether this market psychology was supported by commercial and/or governmental endeavors is unanswered here, but it does seem to demonstrate a correlation between economic expansion and investor participation.

Despite an increase in individual investing, the type of investing those investors engage in on average may be of lower risk. According to 'The Ultimate Investor' a book by Dean LeBaron and Romesh Vatilingam, cited studies indicate investors are indeed risk averse on average. This means long-term investing in lower risk financial instruments is more likely than higher risk financial choices according to the study. Thus, individual investing may be on the rise, but not necessarily in high risk kind of way.

Impact of U.S. Presidential Elections on Capital Markets

It is a long held notion among investors and market speculators that election years tend to be good years for capital markets. This notion has been reinforced by observations of market performance over several decades and in some cases the last century or longer. However, for the market observations to proven as related to election years, different methods of accuracy testing can be applied to the observations including quantitative and statistical analysis. While economics and market conditions cannot be measured with the same levels of empirical accuracy as some scientific research, the application of the aforementioned analytics help confirm or disconfirm the notion U.S. presidential elections do in fact impact capital markets.

Statistical Positive Election Year Capital Market Performance:

Statistically, United States presidential election years have had a favorable correlation with capital market performance. According USA Today, a national U.S. newspaper, "Election years usually bring good news for stocks", the caveat being the usually it does implication. To illustrate, the newspaper took note of the annual performance of the Dow Jones industrial average, a composite stock index, from the years 1964-2000. Of the 10 election years since then only 1 yielded a negative return and the average of all the annual yields was 9.3%.

Similar reports and statistical measurements have been reported from other observers, one such example being the online magazine www.entrapreneur.com which looked at the S&P 500 returns since the 1928. According to that report, the S&P 500 has yielded 2.9% more in election years than non-election years and has averaged 12.6% returns in election years. Yet another examination by www.investmentu.com has put the chances of the "stock market" going higher at 75% since 1888.

So clearly there is a positive trend but does this actually mean US presidential elections actually influence capital markets? Not exactly, while there is clearly a correlation, correlations are not absolute statements and therefore the statement election years influence capital markets cannot definitively be made. Moreover, the capital markets are generally more inclined to "up" years than "down" years based on historical graphing. What can be said is there may be factors that influence the capital markets during election years that are not present or not as great as non-election years.

Market Psychology During Election Years:

Another factor that is considered to effect capital market performance is market psychology. Market psychology includes the sentiments and confidence levels of investors during specific time periods, and in this case that time period is the election year. Market psychology can be measured through surveys, online opinion polls, investment patterns, consumer behavior etc. These measurements can consequently be tested for validity using statistical analysis.

One type of statistical analysis is statistical hypothesis testing through comparing null and alternative hypotheses and then weighing statistical significance using p-values. This method takes to positions i.e. alternate and null-hypothesis such as election years are favorable to capital markets and election years are not favorable, and tests them for accuracy using market information. In other words, hypothesis testing is another way to measure the accuracy of the relationship between variables.

If a sample population is surveyed on their confidence level in the capital markets during election years, the results may demonstrate the alternative hypothesis of favorable confidence in the capital markets is present thus validating the market psychology theory behind the capital market performance given statistical significance i.e. accuracy as measure by P-values.

Administrative Behavior and Ensuing Hypothetical Influences on Capital Markets:

Additional considerations one might give to the historical performance of capital markets during election years is the behavior of Government officials and Government agencies in election years. One such pattern of behavior includes the actions of the U.S. Federal Reserve Bank and the President, or the campaign platforms of Presidential candidates and legislation passed by the House of Representatives and the Senate.

While such election year behavior and administrative actions may be influential factors on capital market performance, drawing the conclusion such actions were intended and originated to influence the capital markets can be considered speculation as Governments have more than capital markets on their political agendas, i.e. the economy in general, base demographic support, legislative agendas, international politics etc.

The aforementioned campaign agendas of Presidential candidates may further inspire sectors of the capital markets that would be beneficiaries of the presidential platform. For example in 2008, the prices of gasoline and other fossil fuels reached new highs. The concern about the rising price of fuel to businesses and individuals alike may spur concern for a campaign platform position regarding energy conservation, improved efficiency standards, implementation of renewable energy etc.

Consequently, should the leading candidates have specific platform positions, this has the potential to, but not a guarantee to influence the movement of certain commodities, and/or ownership of securities within particular industries. These patterns are hypothetical as single isolated factors generally aren't the only factors that influence capital markets. In other words, the capital markets are quite large and influenced by more than just political agendas, however political agendas may be a contributing variable.

To recap, U.S. capital markets have been observed to outperform, if not yield positive returns during election years. This pattern has been quantitatively measured through graphical and historical metrics. The accuracy of these measurements can be tested for accuracy, in part, using statistical analysis. The statistical analysis measures accuracy of relationship and also tests hypotheses relating to the election year and capital market performance.

Since statistical analysis is not an absolute science, it is subject to error and this is vulnerable to speculative oversight. For this reason, the connection between election years and capital market performance, in addition to the variables that appear to influence this connection such as market psychology and government behavior tend to be somewhat speculative despite the evident historical patterns that are present in capital markets during election years.

Sources:
1. http://www.usatoday.com/money/markets/us/2004-01-26-martelection_x.htm
2. http://www.entrepreneur.com/magazine/entrepreneur/2007/october/184386.html
3. http://www.investmentu.com/IUEL/2003/20031218.html
4. http://www.usnews.com/usnews/biztech/articles/040119/19elect_2.htm