With the S&P 500 up 9% this year and 25% above its October low, you would think that investors would be dancing in the streets.
And maybe they would if more of them had profited from the run-up.
But if the celebration after the Dow Jones Industrial Average cleared the 13,000 mark last week for the first time since 2008 seemed somewhat muted, that is because retail investors pretty much gave equities the cold shoulder during the recent rally while continuing their warm embrace of fixed income.
Investors added $5.4 billion to equity mutual funds during the first three weeks of February but poured a net $23.6 billion into bond funds, according to the most recent mutual fund flow data from the Investment Company Institute.
"SHELLSHOCKED' CONSUMERS
In fact, since the end of April, the stock fund category has seen nine consecutive months of net outflows, totaling $168.4 billion. During the same period, net flows into bond funds totaled $146.9 billion.
Why such little enthusiasm for equities among individual investors?
“The consumer was completely shellshocked by the financial crisis,” said Jim Russell, chief equity strategist at U.S. Bank Wealth Management, which has $101 billion under management.
New concerns, he added, include a “lack of visibility on tax policy,” and some of the proposals in President Barack Obama's budget.
“People just don't want to dive into the pool here,” Mr. Russell said.
Quincy Krosby, market strategist at Prudential Financial Inc., de-scribed the equity market environment as a kind of tug-of-war between bears and bulls.
Bears hold that there is good reason to worry. In essence, they think that the U.S. equity markets are turning a blind eye toward the European debt crisis and likely recession, a potential economic slowdown in China, rising turmoil in the Middle East, as well a domestic picture that includes high unemployment, an abysmal housing market and rapidly rising gas prices.
Investors should recognize the various head winds and expect stock market volatility to continue, said Frank Germana, U.S. equity specialist at J.P. Morgan Asset Management.
“I'd have to say the market is fragile at this point, and we could start to see some selling pressure,” he said.
“I really don't have a lot of confidence in the recent run-up,” said Jason Moore, president of Moore Financial Strategies LLC, which advises clients on a flat-fee and retainer basis. “I think there are still too many negative pressures on the markets to continue this rally.”
Not everyone shares that view.
“I agree that there are a lot of reasons the market shouldn't be doing as well as it is, but they are all fairly well-known and therefore already factored in,” said Adrian Day, president of Adrian Day Asset Management, which manages $180 million.
Matthew Lloyd, chief investment strategist at Advisors Asset Management Inc., thinks that the relative lack of investor participation represents a large part of the market's momentum.
“Right now, the stock market is following the path of least resistance,” he said. “There are not a lot of people willing to short this market, even as a hedge, and that gives you a bias to the upside.”
Even considering all the macro reasons to bet against the stock market right now, Mr. Lloyd said that the fundamental data favor equities.
For example, the S&P 500, at 2.2 times book value, is at a 27% discount to its historical average book value of three times book.
The benchmark is also trading at 7.8 times cash flow, which is a 30% discount to the historical average of 12 times.
On a price-earnings basis, the benchmark's 14 P/E is at a 28% discount to the 19.4 P/E average since 1986.
But with the U.S. equity markets now back up to mid-2008 levels, there is a natural tendency to brace for some kind of pullback, according to Peter Tuz, president of Chase Investment Counsel Corp., a $700 million asset management firm.
"BACKING AND FILLING'
“A strong number like 13,000 on the Dow might bring some people back into the market that haven't been in since they sold at the bottom in 2009,” he said. “But it's hard to tell if this market is going up or down from here, because we might need some backing and filling after such a strong start to the year.”
And based on historical patterns showing that retail investors tend to be the last to join a market rally — and often buy near the top — a big move by retail investors at this point could be seen as a negative market indicator.
“As always, the retail investor will be late and gradual in getting back into the market,” Mr. Russell said.
Of course, the flip side of having retail investors sit on the sidelines is that a major political or economic event is less likely to send the market into a tailspin, as there would be fewer retail investors fleeing.
“The fact that retail investors are still generally underweight equities means they don't have enough to dump if they get scared,” Mr. Day said.
jbenjamin@investmentnews.com
