Daily Gains Letter

Three Reasons Why Institutions Are Buying Stocks and Why Investors Need to Be Extremely Cautious

By for Daily Gains Letter |

Investors Need to Be Extremely CautiousVery soon, the stock market will be overbought. It’s time to be extremely cautious.

Even in the face of mixed earnings and economic news, institutional investors keep buying this market. And while fundamentals don’t particularly support a rising stock market, there are a number of reasons why institutions have to buy. Here are just three of the reasons:

1. They Have the Money

There is a tremendous amount of cash sitting on the sidelines. Both individual and institutional investors have been very frazzled over the last few years, and corporations have, as well.

Earnings results from large mutual funds and investment corporations recently revealed billions of dollars of new cash inflows allocated to equities. That money has to be put to work, because that’s what customers are paying for.

2. There Is Nowhere Else to Go

Because interest rates are so artificially low, there is no other asset class, other than real estate, where investors can allocate their capital and expect to get a return that is greater than the rate of inflation.

Even if the stock market doesn’t do anything and corporations don’t show any growth in earnings, dividend payments and share buybacks are very well assured.

Institutional investors need to invest in this stock market, because bonds, currencies, and commodities no longer offer the right combination of income, safety, and prospective capital gains. This is why so many blue chips have been outperforming—they offer what the rest of the world does not.

3. They Have to Keep Up with the Joneses

Without a doubt, a herd mentality exists on Wall Street. Investment companies have been chasing the safest names in the stock market, and because of this, the positive trading action is actually feeding itself.

Portfolio managers do not want to look bad—they are paid based on performance. With such little real economic growth available, those companies that provide a combination of earnings growth and rising dividends are coveted by all. Therefore, the share price action becomes even more pronounced.

This is why it is so extremely important to be highly cautious right now. The stock market is still ticking higher, but we know from first-quarter earnings results that revenue growth is elusive.

While paper gains are useful, it is a dangerous environment that cannot last unless earnings suddenly take off.

The stock market is almost always a leading indicator, especially over Main Street. Clearly, institutional investors are making a bet that the U.S. economy and corporate earnings will get better.

The current environment is a time to reap profits from the stock market, not sow new positions. A healthy dose of caution is very much appropriate.

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