Few Believers

9/10/2012


Consider the following statistics:

• The S&P 500 Index has produced positive total returns in three consecutive years and eight of the last nine years. (Actually, it's four straight and nine out of the last 10 if you include year-to-date 2012 returns.)

• The Dow Jones Industrial Average has risen nearly 7% this year and is just 8% from its all-time high.

• The yield on the S&P 500 Index is greater than the yield on a 10-year Treasury bond, nearly four times the rate of a five-year Treasury, and 14 times the rate of a one-year Treasury.

• U.S corporate profits, a major driver of stock prices, should set an all-time record this year.

Against this backdrop of market strength, record corporate profits, and scant yields on fixed-income investments, you might expect investors to be ebullient about stocks.

You'd be wrong.

Investor sentiment towards stocks remains, in a word, skeptical. This skepticism shows up in a number of data points:

• Investors continue to favor bonds over stocks. Through July of this year, just $611 million had flowed into open-end and exchange-traded stock funds, versus nearly $213 billion in net inflows to bond funds.

• Adviser sentiment remains somewhat cautious toward stocks as well. According to Investors Intelligence, 49% of advisers are either bearish or calling for a correction, the lowest since March but still well above levels seen at the end of 2010 and early 2011.

• Corporate insiders don't seem to be buying the market. Recent insider buying is running near its lowest levels this year, according to InsiderCow.com.

• Bank of America/Merrill Lynch's sell-side indicator, which measures Wall Street sentiment based on strategists' recommendations on equity exposure, is at 27-year extremes in terms of bearishness.

What is causing this skepticism? Obviously, investors haven't forgotten the carnage caused by the S&P 500's one down year in the last decade — the 37% shellacking in 2008 — and continue to anchor on the pain of that year. In addition, political uncertainty hinders investor enthusiasm for stocks. The election in November and the impending fiscal cliff — automatic spending cuts and tax hikes that will occur at the end of this year unless Congress and the president can reach a budget compromise — give investors convenient reasons to sit on their hands and avoid stocks. Investors and advisers also worry about global economic growth.

Meager 1.7% economic growth in the U.S. is near the top of the leader board of developed countries, and previous economic juggernauts, notably China and Brazil, are idling down. It's not surprising that many investors view the market's ability to move higher with a mixture of surprise, bewilderment, and disbelief. "Most of the other talking heads on television . . . have dismissed this recent market rally," says the Financial Research Center Investment Letter. "First, they told you it couldn't happen. Then, as it was happening, they said it wouldn't continue. Now that we have recovered all the losses since April, most are saying that the gains won't likely be sustained — and forget about the notion that stocks can continue to climb higher."

Some investors expect the economy to improve in 2013. "We sense that the cloud cover will lift slowly, most likely as we move into the early-to-middle stages of 2013," says The Value Line Investment Survey. Reasons for optimism include the "long-overdue recovery that seems to be evolving on the housing front (and) the commitment by the Federal Reserve to maintain a very accommodative monetary policy."

Ironically, the very reasons given by investors for optimism for 2013 make a bullish case for investing in stocks today. The stock market looks forward, and so should investors. If you believe the outlook for the economy and stock market brightens next year, the time to buy is not next year. It's today. If you wait until the improvement occurs, stock prices should have already jumped.

Bottom line: Investors skeptical about stocks because of what they see in the world today are making a common mistake. The market has at least partially discounted today's news and already looks forward.


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