Living in the Past: Investors Finally Putting Away the Rear-View Mirror?
- Stocks have staged an impressive run toward all-time highs, and retail investors are beginning to notice.
- Short-term sentiment has gotten a little frothy and concerning, but longer term, there are few major warning signs.
- Analyzing the "cash bubble" through the eyes of a legendary investor.
We all know the phrase, "If a tree falls in the forest and no one is there to hear it, does it make a sound?" Well, if the stock market rises and approaches all-time highs, but investors remain dour and disbelieving, is it really a bull market? I used "disbelieving" because of this amazing investor survey I recently saw from Franklin Templeton (FT).
FT asked a large group of investors whether they thought the stock market was up or down in 2009, 2010 and 2011. As you can see in the graphic below, around half of surveyed investors weren't even aware the market had gone up each year post-crisis. And of course, we can now add 2012 to the string. I'm guessing if FT were to conduct the survey again about 2012, a larger percentage of investors would at least be aware of last year's stellar 16% gain for the S&P 500® Index.
Many Investors in Dark About Bull Market's GainsSurge
Source: Bloomberg, Franklin Templeton Investments. Used with Permission. The 2010 Franklin Templeton Global Investor Sentiment Survey designed in partnership with ORC International. Included 1,010 telephone responses from participants age 18 and older in the United States from March 25, 2010 to March 28, 2010. The 2011 Franklin Templeton Global Investor Sentiment Survey designed in partnership with ORC International. Included 1,049 online responses from participants age 18 and older in the United States from January 6, 2011 to January 7, 2011. The 2012 Franklin Templeton Global Investor Sentiment Survey designed in partnership with Duke University professor Dan Ariely and Qualtrics. Included 1,142 online responses from participants age 18 and older in the United States from January 30, 2012 to February 13, 2012.
A greater sense of awareness may be a result of the stock market being a sliver from its all-time highs. Actually, the Wilshire 5000 Total Market Index, the broadest measure of stocks, did already take out its all-time high. The Dow Jones Industrial Average and S&P 500 have it in their sights, while the NASDAQ still has a ways to go. The chart below is for the S&P 500, and highlights the progression of stocks since the epic trough in March 2009.
Stocks Make a Near-Round Trip
Source: FactSet, as of February 27, 2013. Dotted line represents S&P 500 peak.
50%-off sale all-but ignored
It's always remarkable to observe the psychology of investors during market cycles. With nearly everything else, people prefer lower prices and get very excited about 50%-off sales—but not so with stocks. It's the near-round trip stocks have been on since 2009 that has individual investors finally intrigued again. But it's human nature; so many investors were badly burned by two major bubbles bursting since 2000, their confidence remains sapped.
However, shorter-term measures of investor sentiment are flashing a bit red, i.e., optimism has been rising. An index I often highlight, the Crowd Sentiment Poll put out by Ned Davis Research (NDR), shows investor sentiment remains in the "excessive optimism" zone—a zone in which the market has historically had some difficulty.
We do believe the market has some vulnerability in the short-term. But it would likely only be a short-term consolidation, because longer-term measures of investor sentiment—both attitudinal and action-oriented—still show ample skepticism. In a phrase, the "wall of worry" hasn't been toppled.
Retail investors starting to embrace stocks
In fact, for nearly the entire duration of this near-four-year bull market, retail investors have been net sellers of stocks, as measured by record-breaking outflows from stock mutual funds. In three of those four years, the S&P 500 had double-digit returns, albeit with corrections along the way (which is normal). Most telling has been the reaction to the corrections—imminent fears that the next collapse was on its way. All the while, corporate profits have been chugging along, the economy has been slowly recovering, and companies have been buying back their stocks—the primary push under the market to date.
The trend may be turning, however. There have been very strong inflows into stock funds so far in 2013. In fact, nearly all fund categories have seen strong inflows, with the funding coming from cash via money market mutual funds. The surge has certainly been helped by the strong performance stocks posted in January.
There's already talk that retail investors are buying into a market top. But keep this in mind: according to the Investment Company Institute, nearly $550 billion came out of stock mutual funds in the past five years, until the reversal in January 2013 which saw about $19 billion of inflows, a mere fraction of the prior drain. It's way too soon to call this the "dumb money."
The S&P 500's 5.2% total return for January ranks as the best January since 1997. The rally triggered a bullish signal from NDR's January Barometer indicator, which states that a positive January bodes well for the rest of the year.
January Effect Summary Statistics
"As January Goes, So Goes the Year"
Source: Ned Davis Research (NDR), Inc. Further distribution prohibited without prior permission. Copyright 2013 © Ned Davis Research, Inc. All rights reserved, as of January 31, 2013. Strong January defined as gain greater than five percent. Lines reflect average performance.
In sum, since 1928, when the S&P 500 has risen in January, it's climbed an average of 8.3% for the next 11 months and was up over that span nearly 78% of the time. When the S&P 500 has fallen in January, it's risen only 58% of the time for an average of only 2.8%. That said, the chart above does show some consolidation has occurred before the market has headed higher—consistent with our thinking that a pullback could occur at any time. But for the intermediate term, the market is waving no major warning flags. There are always very intelligent bears to be found providing a long list of negatives … but they've been wrong for several years and, there's not presently evidence that their concerns are budding to the surface.
Challenges remain, but liquidity holds the key
Yes, challenges remain: the eurozone debt crisis and attendant recession(s), Middle East unrest, US debt ceiling/sequestration deadlines and a still-weak global economic recovery. And although I do spend a lot of time researching and writing about how the economy affects the stock market (and vice versa), I've also learned that the monetary and liquidity cycles are most important to the stock market in the shorter term.
"Don't fight the Fed" was a phrase coined by famed investor Marty Zweig—my boss from 1986-1999—who sadly passed away on February 18. It's no less true today. He used to pair that phrase with "the trend is your friend," and clearly that's been in play these past few years, too. Periods of monetary expansion combined with low inflation have generally been heady juice for stocks.
On liquidity and the "bubble of cash:"
A fascinating take on the subject came from the most successful hedge fund investor in history—Bridgewater's Ray Dalio—speaking on a Bloomberg panel at the World Economic Forum in Davos in January:
"What's happened now is that because of all the money that's been added to the system, there's a great deal of liquidity in the world. So there's money in corporations; in households. Liquidity is all over the place; a lot of it. And it's gone there because of monetary policy, and it's also gone there seeking safety.
"That's changing on the margin. The returns on cash are terrible. So as a result of that, what we have is a lot of money in a place—and it needed to go there to make up for the contraction in credit—but a lot of money that is getting a very bad return. That, in this particular year, in my opinion, will shift. And the complexion of the world will change as that money goes from cash into other things.
"There's too much liquidity and so bonds are a poor investment; they'll have a poor return. Cash will have an even worse return; that's assured. And that's a bubble…too much money in there. So the cash bubble exists, but we're reaching an equilibrium in terms of the debt growth."
Investors with money sitting in "safe" assets are beginning to find that things are not quite as safe as they thought.
I believe we've entered the fourth of four typical phases of stock bull markets. My friend Laszlo Birinyi categorizes the phases as reluctance, consolidation, acceptance and exuberance. And for those concerned that we're in the final phase, do note that the first and fourth have generated the best performance historically. For now, I'd classify the exuberance phase as of the "rational" variety, distinctly different from the "irrational exuberance" that defined the latter stages of the 1990s bull market.
So, what's a sidelined investor to do?
Trading short-term moves in the stock market can be treacherous, and it's why we don't suggest investors attempt to do it. But many investors don't even have a long-term plan, let alone a short-term desire to pick tops and bottoms. There's no better time to have a well-designed, long-term plan which includes an asset allocation structure that's established precisely around your risk tolerance and geared to achieve your long-term goals.
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