Global Tumult Sends Many Investors Back to Sidelines

"Just when I thought I was out, they pull me back in," the aging Mob boss Michael Corleone famously complained in the "Godfather III" gangster epic. Had Don Vito's youngest son been a stock market investor, he might be saying just the opposite these days.

A local investor watches the share-prices index display at a stock brokerage in Shanghai.
Liu Jin | AFP | Getty Images
A local investor watches the share-prices index display at a stock brokerage in Shanghai.

Faced with one global disruption after another, the retail investor has headed back for the sidelines, getting out instead of going back in due to the volatility created in Japan, Libya, Bahrain and points elsewhere around the globe.

The result: A return to a trader's-market atmosphere where one day's events can make the previous day's irrelevant and cast the investment climate in an entirely different light.

The Japan earthquake and ensuing tsunami, combined with pervasive fears over a nuclear meltdown and destabilization of the Asian nation's currency, are only the latest example in a brutal stretch of turmoil for the global markets.

"Until investors know the extent of the damage and nuclear fallout in Japan, the only certainty in the capital markets is that uncertainty will prevail," Nicholas Colas, chief equity strategist at BNY ConvergEx in New York wrote in a research note for clients.

"Financial assets require a special alchemy of investor confidence and positive fundamentals to appreciate in value," he added. "Even if the US economy has been exhibiting some of the second, the loss of the first offsets any benefit."

The results have shown up vividly in the flow of investor money.

US equity mutual funds had been on a nice two-month streak of positive inflows that saw more than $22 billion stream in. But that has reversed in the past two weeks, with some $4.3 billion coming out as the violence in Libya intensified and oil prices surged. Those figures, from the Investment Company Institute, do not include flows since the disaster in Japan.

"We'll be getting news from the tragedy in Japan for weeks, if not months. Some of it hopefully will be good. Other parts will clearly be much worse," Colas wrote. "But it seems too optimistic to believe that global capital markets can rapidly and efficiently discount a disaster of this magnitude."

Investor jitters, and the trend toward a short-term view of market movements, have manifested themselves in a number of ways.

Bond magnate Bill Gross of Pimco posted a Twitter message Thursday advising investors that "stronger economic news plus hope for calm in Japan favor risk trades, not Treasuries" but put the time frame "over the next 1 to 2 days."

Hedge fund manager Dennis Gartman, author of The Gartman Letter, boasted of having the good sense to bail on yen trading after the Japan crisis broke, saying, "[W]e were taken to task for reversing our position and heading to the safety of the sidelines on such 'flimsy' news as was then extant. Our decision has since been proven to be the proper one."

While Gartman takes a much shorter-term view of the market than, say, a mutual fund investor, a shift in sentiment surveys to a bearish mood suggest that he could get company on the sidelines. It's a worrisome prospect for some advisors.

"That would be the wrong move," said Beth Larson, principal at Evermay Wealth Management in Washington, D.C. "The fact is, the US market is still the safest place to be in terms of equity investing."

Though that may prove to be true, trends suggest that in the near term there's just too much noise to trust the domestic market, even considering Thursday's relief rallywhere volume was anemic despite the surge higher.

Colas said all but one of the 18 sectors he tracks—high grade corporate bonds being the exception—are showing significantly higher levels in implied volatility.

Confusion over whether the Japanese government will take actions to suppress the nation's rapidly rising yenserved as the latest market agitation, though some pros said too much was being made of the uncertainty.

"There's nothing unique about this. That's a situation almost every day in investing," said James Paulsen, chief investment strategist at Wells Capital Management in Minneapolis. "To come to the conclusion that you just can't do anything when you don't know—for me that would mean I would never do a trade."

As it stands, Paulsen said his own quick move this week was to increase his exposure to Japan by 2 percent, selling off some exposure to the CBOE Volatility Index, which is designed to track market unease, and cutting his safe-haven play by buying the ProShares UltraShort Lehman Brothers 20+ Treasurys ETF, which plays against longer-term government debt.

Yet things could change quickly.

A stronger yen could put pressure on global markets by increasing the costs of Japanese exports, which simultaneously could hinder a recovery in the disaster-ravaged nation.

"That's a huge catastrophe that's going to put upward pressure on the yen for at least a few more months," said Kurt Karl, chief US economist for Swiss Re in New York. "It's going to be interesting watching all the movements."

As indicated by recent investor behavior, much of the market may just choose to sit out all the fluctuation.

"Usually (a rising yen) is correlated with weaker equities, and I think that's the case this time," said Richard Hastings, chief strategist at Global Hunter Securities in Newport Beach, Calif. "You've got enough other stuff going on that equities were going to take a beating anyway."